TE Connectivity plc (TEL) — Q1 2018 Earnings Call Transcript

Good morning. And thank you for joining our conference call to discuss TE Connectivity's fourth quarter 2018 results. With me today are Chief Executive Officer, Terrence Curtin; Chief Financial Officer, Heath Mitts. During this call, we will be providing certain forward-looking information and we ask you to review the forward-looking cautionary statements included in today's press release. In addition, we will use certain non-GAAP measures in our discussion this morning and we ask you to review the sections of our press release, accompanying slide presentation that addresses 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. Finally, for participants on the Q&A portion of today's call, I'll remind everyone to limit themselves to one follow-up question to make sure we can cover all questions during the allotted time. Now, let me turn the call over to Terrence for opening comments.

Thank you, Sujal. And thank you, everyone, for joining us today. Before I get into our first quarter results and our guidance for the year, I want to spend a little time recapping the key messages from the Investor Day we held last month in New York. And I really want to thank those of you that joined us. As you know, during that Investor Day, we laid out the strategic direction of TE, as well as our position as an industrial technology leader. In that sense, the key messages we highlighted during Investor Day, which are shown on slide three of the slide deck we posted this morning, really were around, first, we built a portfolio with clear competitive advantages and we are positioned to deliver above-market growth. Secondly, the markets we serve have attractive secular trends and are benefitting from the content growth across all of our segments. Thirdly, when we create value, it's through the work we do with our customers through strong differentiation, very much engineering intimacy through where we design with them in their architecture, and the scale and our leading global presence. Lastly, we have a strong business model that has not only the growth levers about the three I just talked about, but also leverage to expand profitability, while when we use the cash from our attractive business model, we maintain an attractive return on capital. When we talked about the strong business model, we also laid out targets for you. Targets where we believe the annual organic growth of our business model can be 4% to 6%. We can continue to drive annual margin expansion of 30 to 80 basis points per year, as well as double-digit EPS growth. We also highlighted our M&A strategy, which indicated that we can add over 100 basis points per year, which adds to our organic growth through acquisition because of the breadth of the markets we play in. As Heath and I are going to highlight over the next 20 minutes or so, I'm very pleased about not only our strong results in the quarter and updated guidance for the fiscal year. I believe the performance you're seeing demonstrates the key messages that we laid out at Investor Day and strong execution by our teams that align with the business model we outlined. So, if you could, let's please turn to slide four and let's get into the results for the quarter. We again delivered performance above guidance with double-digit growth in revenue and adjusted earnings per share. Sales during the quarter were $3.5 billion and this represented 14% reported growth and 8% organic growth year-over-year. In our Transportation segment, we grew 13% organically with double-digit growth across all three of our businesses. Industrial Solutions grew 6% organically, driven primarily by continued strength in our industrial equipment applications. Our Communications segment declined 6% organically year-over-year due to a decline in SubCom, but we did see 10% combined organic growth in our data and devices and appliances businesses in the quarter. When I think about last year, we talked about performance across our portfolios, with operating margin expansion across all three segments. In our first quarter, we delivered record profitability with adjusted operating margins of 17.9%, driven by margin expansion in the Industrial segment, which was one of the key levers we laid out for you at Investor Day. Adjusted earnings per share grew a very strong 22% to $1.40, and this is a record on a quarterly basis for our company. Based upon this very strong start for the full year, we are raising our annual sales and adjusted earnings per share guidance. Our organic growth expectations are being raised from 4% to 5% for the year, reflecting stronger first-half momentum and the second half of the fiscal year that is in line with our prior view. We are raising our outlook for reported sales from 6% to 8%, reflecting 100 basis points of the organic growth increase and the remaining 100 basis points from the impact of currency exchange rates. On an adjusted EPS perspective, our expectations are being raised by $0.22 to $5.45 per share, which represents 13% growth year-over-year, and I'll add more color towards the end of the call around our guidance. The other thing I want to highlight is the continued strong momentum in our orders, with organic orders up 22% year-over-year. Excluding SubCom, which had a very strong order quarter, orders were up 11% with growth across all regions. So, if you can please turn to slide five, let me get into orders in more detail and the trends that we're seeing across orders. We continue to see broad-based strength in orders across all three of our segments, which reinforces our growth outlook. Total orders, excluding SubCom, exceeded $3.5 billion with a book to bill of 1.06. Orders were up 17% year-over-year on a reported basis and up 11% organically. We also continue to see broad-based strength globally. Excluding SubCom, our orders organically grew 16% in Europe, 15% in the Americas, and 3% in Asia. Turning to segment orders by segment. In Transportation, orders increased 13% organically, with growth in all regions and strength especially in Europe, where we saw order growth of 17%. We also saw the year-over-year order growth in each of our three businesses in Transportation. Industrial orders grew 8% organically year-over-year, with growth across all regions and continued strength in our industrial equipment business. In Communications, excluding SubCom, we saw year-over-year organic growth of 7% in orders, with growth across all regions. And then, for SubCom, which we had carved out until now, we had a very strong booking quarter. Year-to-date, we booked project orders of $400 million, which has raised our total backlog above $1 billion in SubCom and reinforces the health of the current SubCom market cycle. So, if you could, let me turn from orders and start getting into our segment results. As always, we'll start with Transportation. Transportation sales grew 13% organically year-over-year. Segment revenue exceeded expectations due to strong auto sales across regions. Growth across all submarkets in commercial transportation and 11% organic growth in sensors. Operating margins were at 21%, which was above our expectations and up 330 basis points sequentially, returning to our normalized margin levels of 20% plus or minus midpoint. In auto specifically, our sales were up 10% organically, significantly above auto production trends, which are in the low single digits. We are benefiting not only from content growth but also from our leading global position. We had growth in the teens in Europe as well as in the Americas, and mid-single growth in Asia. We also continue to benefit from new program ramps, which contribute to our outperformance versus vehicle production levels. As we highlighted during investor day, while the hybrid electric and EV market is still a small percentage of overall vehicle production, we continue to be extremely well-positioned with leading-edge solutions and wins across all major OEMs across that technology. Turning to our commercial transportation business, we continue to outperform the market with organic revenue growth of 34% year-over-year, with balanced growth across all regions and growth within each submarket. While last year, we benefited from the trends we saw in heavy trucks, this year, we're seeing continued momentum in heavy truck, as well as experiencing growth in agriculture, mining, and construction markets globally. In our sensors business, we grew 11% organically year-on-year with growth across all markets, including auto, commercial transportation, and industrial end markets. As we highlighted for you on investor day, we continue to see strong design win momentum, particularly in auto applications, where we've generated $1.2 billion of new design wins over the past two years across many different sensor applications as well as technologies. Now, let me turn to the industrial segment, and if you can please turn to slide seven, we'll get into it by business. On an overall segment basis, sales grew 11% on a reported basis and 6% organically. Operating margins were at 14% and expanded 270 basis points year-over-year, driven by strong operating leverage on higher volume. By business in the segment, in industrial equipment, organic order growth was 17%, with growth across all regions and strength in factory automation and medical applications. As we mentioned last month, we are focused on high-growth applications such as robotics and interventional medicine. Our strong position in high-growth markets, coupled with acquisitions in these areas, are driving superior growth ahead of the market. In our aerospace, defense, and marine business, we saw a slight organic decline of 2%, which was driven by commercial aerospace. While sales have been impacted by project timing over the past couple of quarters, we do expect this business to grow this year with the strong content wins that we highlighted to you during investor day. In our energy business, it declined 6% organically, primarily driven by the weakness in the overall European power market. If you can please turn to slide eight, let me cover Communications Solutions. The segment declined 6% organically due to the ramp-up delays in the new SubCom program that I mentioned. This impact more than offset continued growth momentum in our data and devices and appliance businesses, which had a combined 10% organic growth in the quarter. In data and devices, we grew 2% organically, driven by strength in Asia and continued growth in high-speed connectivity and data center applications. As we highlighted during investor day, we shifted our portfolio to growing high-speed applications that have complex technological challenges to meet the high-speed requirements. We continue to benefit from our position with our hyperscale customers, and we continue to drive margin growth through optimized operations in this business. In our appliance business, we had another strong quarter with 22% organic growth and double-digit growth in all regions as we continue to benefit from trends in this area, including safety, efficiency, and miniaturization. Over the past several quarters, our performance in appliances was driven by share gains and product cycles in China. What was really nice about the first quarter and our guidance for the year is it's been driven by our leading global position, and we're seeing higher demands in the Americas and Europe, contributing to the growth of our solutions. The growth is becoming much more balanced in appliances for this year. Lastly, in SubCom, revenue and margins were impacted by the ramp-up delay in the new program, which we have resolved. We do expect a couple of quarters of margin impact due to the project accounting nature of this business, but the SubCom market cycle remains very healthy. These programs we just announced with significant customers have brought our backlog to over $1 billion, as I previously mentioned. From a margin perspective, segment adjusted operating margins declined to 11.8% in the quarter, reflecting the SubCom ramp-up delay. We expect this segment to run below our expected mid-teen operating margins for the next couple of quarters and then expand as we close the year. Now, let me turn it over to Heath who will cover the financials.

Thank you, Terrence. And good morning, everyone. Please turn to slide nine where I will provide more details on Q1 financials. Adjusted operating income was $623 million, with an adjusted operating margin of 17.9%, leveraging the strong organic growth of 8%. GAAP operating income was $581 million and included $35 million of restructuring charges and $7 million of acquisition charges. For the full year, I continue to expect restructuring charges of approximately $150 million, driven primarily by activity in our Industrial Solutions segment as we optimize the footprint and make structural improvements across our TE cost structure. Adjusted EPS was $1.40, up a very strong 22% year-over-year, primarily driven by sales growth and operating margin improvement. For the quarter, our adjusted EPS performance was $0.15 above our prior guidance midpoint due to the strong revenue performance and operating income follow-through. GAAP EPS was a loss of $0.11 for the quarter and included a one-time tax-related charge of $1.42 of EPS, primarily due to the recently passed US tax legislation and restructuring and acquisition-related charges of $0.09. Because of the reduction in the US corporate tax rate, we recorded a charge to income tax expense of approximately $500 million to write down our US deferred income tax assets. In Q1, our adjusted effective tax rate was 17.3%. As we stated on our last call, we expect a full-year tax rate in the 19% to 20% range and we now expect taxes to come in at the lower end of that range. For Q2, we expect our adjusted effective tax rate to be approximately 19%. Now, if you turn to slide ten, please. As a reminder, the first quarter of 2017 was exceptionally strong, so we have some tough comparisons on a year-over-year basis. However, if you look at our performance sequentially, we continue to demonstrate the consistent progress we're making as a company. Our strong Q1 results demonstrate that we're performing well against our business model and executing upon multiple levers to drive earnings growth, including organic growth, consistent capital deployment strategy of M&A and return of capital to our owners, and margin expansion through TE OA and cost reduction efforts. Adjusted gross margin in the quarter was 34%, down from prior year, but up 100 basis points sequentially. Adjusted operating margins were up 10 basis points year-over-year to 17.9%, a record for the company. Adjusted operating margins were up 160 basis points sequentially, with organic growth driving leverage in the operating structure of the company. Our business continues to generate solid free cash flow. In the quarter, cash from operations was $350 million and free cash flow was $127 million, in line with our expectations. We've returned $355 million to shareholders through dividends and share repurchases in the quarter. We've included a balance sheet and cash flow summary in the appendix for additional details. With that, I will turn the call back over to Terrence.

Thanks, Heath. Now, let me get into guidance. Let's start with the second quarter that is on slide 11 of your deck. For the second quarter, we expect revenue of $3.55 billion to $3.65 billion and adjusted earnings per share of $1.33 to $1.37. At the midpoint, this represents reported sales growth of 12%, organic sales growth of 6%, and adjusted earnings per share growth of 13%. By segment, we expect Transportation Solutions to grow mid-teens on a reported basis, which includes the acquisition of Hirschmann, which is a leading provider of antenna technology and products that we acquired late in fiscal 2017. On an organic basis, we expect high-single-digit growth in Transportation. We expect auto to be up high-single-digits in a global auto production environment we estimate to be up 2% year-over-year in the quarter, once again demonstrating outperformance due to content growth. We also expect, in Transportation, strong growth in commercial transportation and continued growth in sensors. In the Industrial Solutions segment, we expect growth of mid-single digits organically, and that growth will be driven by the continued strength of industrial equipment and medical applications. In the Communications segment, we expect low-single-digit growth, driven by continued momentum in data and devices and appliances. Now, let's turn to slide 12 and I'll cover the full-year guidance for 2018. We expect full-year revenue of $14.1 billion to $14.3 billion. This is up $300 million from our prior guidance at midpoint and we expect adjusted earnings per share of $5.40 to $5.50, which is a $0.22 increase versus our prior guidance. At the midpoint, this represents reported sales growth of 8% and organic sales growth of 5%. You should think about the $300 million increase in revenue guidance as $200 million due to organic growth increase in the first half of our fiscal year and the remainder increase due to currency translation. In bridging between our total growth and our organic growth between that 8% and that 5% of our new guidance, we expect acquisitions to add about 100 basis points and currency exchange effects to add the remaining 200 basis points to the growth in 2018 above organic. Adjusted earnings per share growth is expected to be 13% at midpoint, driven by our growth in operating income expansion. While we have a positive impact from EPS, currency exchange effects of $0.11, this is offset entirely by the negative year-over-year impact of $0.12 from a higher adjusted tax rate when we compare to last year. So really, the 13% is driven by operations. Let me provide more color on our segments and our full-year guidance. We expect Transportation Solutions to be up in the low-teens on a reported basis and up high-single-digits organically, representing an improvement from our prior guidance. We expect our auto business to be up high-single-digits organically on 2% auto production growth, reflecting continued content growth and share gains. Commercial transportation is expected to continue to outperform its end market, benefiting from content expansion and share gains, and we expect continued growth momentum in sensors. In Industrial Solutions, our guidance is essentially unchanged from our prior guidance from last quarter and is expected to grow mid-single digits on both a reported and organic basis, with the primary growth drivers being industrial equipment and medical applications. In the Communications segment, we expect to be flat on both a reported and an organic basis, with our growth in data and devices and appliances being offset by the declines in SubCom that we highlighted to you already. In data and devices, we expect to benefit from high-speed ramps to cloud infrastructure customers as well as new design ramps for server OEMs. In appliances, we expect strong growth above the market due to share gains in all regions. In SubCom, we expect revenue to be towards the lower end of our $800 million to $900 million range that we told you about last quarter. In summary, I continue to feel very good about our performance and execution, especially when I think about what we highlighted to you at Investor Day and it really came through during our results in the quarter as well as in this guidance. We have built a portfolio with clear competitive advantages and you're seeing the benefit of our leading positions and content growth driving growth above market, as well as driving margin expansion. Lastly, before we open it up for questions, I do want to thank our global teams for their strong performance in the quarter and ensuring that we bring our technology to our customers to further our leading positions around the world. So now, let's open up for questions. So Sujal, I'll hand it back over to you.

Thank you. Could you please give the instructions for the Q&A session?

Perfect. Thanks a lot, guys. I guess two questions for me. Maybe to start off with – can you just talk about the Industrial segment? Operating margins were fairly strong over here in the quarter. Just trying to understand if you're already starting to see some benefits from the cost optimization initiatives that you guys have laid out in the past, or the improvement you're seeing is more organic and those benefits from cost takeout are more ahead of you? Because I think, historically, Q1 tends to be a trough for operating margins in Industrial and then you see a nice steady ramp-up throughout the year. Just trying to get a sense of if that still transpires.

Amit, thank you for the question. I would say this. The industrial team has been hyper-focused not just on their organic growth opportunities, but also on improving their market structure here. That didn't just start when we started talking about it a little bit more publicly during the Investor Day and some of our pre-calls. However, I would tell you that the benefit that you saw in the quarter was largely around the leverage from that organic revenue growth. We have some significant footprint optimization that we're working on. We'll see more of the benefit of that either later this year or more pointedly into 2019, as that's a multiyear journey to get to those numbers. So, the 14%, we're proud of. I think the teams have worked hard to get there. But this didn't receive a huge benefit from some of the footprint pieces that we've talked about that will be forthcoming. We'll continue to keep you posted over the next several quarters and couple of years.

That's really helpful. And if I can just follow up, I guess, Terrence, for you maybe. I want to better understand the back half expectations you guys have right now for your fiscal year. You clearly have a very strong beat in Q1. Looks like there is some upside to Q2. But is it fair to say you're really not raising your back half expectations a whole lot right now? If that's fair, I'm curious, what gives you the pause for back half, or is it just being conservative to hopefully enable performance like Q1 to sustain throughout the year?

As I said in my comments – thank you for the question, Amit. When you look at the guide, when we think about the year, certainly, we had a strong first quarter. We are teed up for a strong second quarter and we left our back half unchanged. I think when you look at the markets, let's start with the markets, first of all, we see an auto environment that we think production has gotten a little stronger than we guided last quarter. Last quarter, we talked about 1% production growth through the year. We view the year as going to be more 2%. But we do think that production growth is first half loaded and is mainly around Asia and Europe. North America has not changed. The industry markets are sort of as we saw them, so we didn't really change our guidance on the year. Then communications – what's really nice in communications is, while the year is going to be flat, the growth that we had, I think communications is really driven by appliances and D&D. We thought SubCom would cycle down and cycle down a little bit more due to this ramp program. The second half is unchanged. It's really our view of the markets. And we updated you for what we believe we see in front of us and we'll continue to update you as we go forward. But I think it is fair to say, it's the same guidance we gave you three months ago on the second half.

Fair enough. Thanks. And congrats on the quarter, guys.

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

Yes, thank you. Terrence, great to see the overall results and Transportation margins have come back so strongly. Your Transport segment is really decoupling pretty strongly from global production. You know, there had been a few things: content, market position, and new wins. I was wondering, can you give us some sense on how much of this growth is coming from new wins? Regionally, where do you expect the biggest outperformance relative to production over the next few quarters? And I have a follow-up for Heath.

Thank you for the question. Let me take the second half of your question first, Wamsi. When you think about our global position, you're really seeing it this year. Last year, we talked about how we grew double digits on a 3% production environment. A lot of that growth last year came from a very strong China cycle, with significant European production. North America was flat. When you look at this year, North America is going to continue to be flat. Production is going to be down a little bit. That said, like I said in my guidance, it’s going to be high-single-digits. The content is broad-based across all the things we talked about during Investor Day, whether that be electric vehicles or connected cars. Also, we still benefit from new program ramps that contribute to our outperformance in vehicle production levels. Geography-wise, Europe is expected to have the strongest production growth this year. In conclusion, we are experiencing a strong global position and the content growth is global. I mentioned in my prior comments, we grew double-digit in North America in a flat environment. We feel comfortable growing mid-single digit in North America. That market has been flat for years now, which is a testament to what we're bringing to our customers.

Thanks, Terrence. Thanks for the color. Heath, can you comment on how you're thinking about potentially any changes to capital allocation in light of the tax changes? Do you anticipate making any changes operationally in terms of site relocations, etc., in view of these changes? Thanks.

It's a timely question, Wamsi. I appreciate it. The change in US tax regulations that went into effect first part of this year, signed into legislation late calendar 2017, don't have a tremendous impact on how we think about capital allocation. As a Swiss-based company, we don't have a repatriation issue in terms of where our cash is located. The most important thing is, although some of the changes in tax regulations here and other parts of the world, probably put a little bit of pressure on our tax rate, our effective tax rate, over the next couple of years, I could see us moving up 100, 200 basis points, maybe to that 21%, 22% range. The most important thing to point out is our cash tax rate, which is the true economics, is still in the mid- to high-teens. And that doesn't dramatically change due to the change in the policy. So, in terms of payback and returns and return on invested capital in terms of operational decisions and capital allocation, it doesn't have a tremendous impact on us. While the US is an important piece, North America is only a third of our business. We have two-thirds of our business outside the US, and we need to pay attention to those elements as well.

Thanks, Heath.

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

Hey, guys. How are you doing?

Hey, Joe.

Just a question on – kind of a specific question, I guess, on EV. There have been talks from some of the sensor guys about trying to adapt more wireless sensing into some of the bigger applications on the electric powertrain. There's debate about whether or not that's the right choice of technology or not, but I'm curious what you're seeing in that market. Is that something you are trying to look at in your own sensor portfolio? What does that mean for connectors in EV powertrains if something like that is to move forward?

It's a great question. When you look at electric vehicles, everybody is looking because it is so new. It is only about 4 million units when you take EV and plug-in hybrids; it’s still a small part of the market. You're seeing a lot of experimentation around what's the best way not only to get connection and power but also in the most affordable way into the system. So, when you hear about ideas like that, there are many happenings around EV architecture. What’s great for us is we play not just one thing; it's about many things. It's about inlets, the battery, as well as sensors around it. The breadth of our portfolio isn't just about one thing. We have programs that go up to $500 a vehicle—2x content. We're exposed to those trends and the breadth of our products means we're going to benefit whether it's wireless or connected.

Sorry, I just jumped on late with a couple of companies today. But relative to data and devices, it seems like every day I come in, I'm seeing articles about who is spending more on data centers this year, and it seems like a universally good story. I was just curious how your discussions, particularly with some of the hyperscale guys, are going—like Facebook and what they're planning on doing. Are you starting to see initial indications of a real acceleration in that market?

I would say twofold: we get benefits from two areas from those trends. You heard us highlight the wins we have in SubCom, which clearly are the high-speed backbone to make those data centers work from the data traffic, especially with video. We are seeing that in our SubCom order book that we highlighted. The other thing I would say, no different than last year, the amount of growth momentum we have around the cloud in our data and devices business is almost entirely our growth driver in our data and devices business. While we'll talk about growth rates that might be low-single-digits, that cloud activity is where there’s most of the acceleration, while there is slower activity in telco spending and things like that. Overall, the cloud activity we have in our data and device businesses drove the growth last year that you saw, and it continues to be the primary driver of growth today.

How big is that part of your D&D right now?

From a rate perspective, it's about 30%.

Okay, great.

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

Morning. And my congrats on the results as well. Two questions, if I may. The Transportation margins rebounded nicely in the quarter. Are there any lingering issues within that business in terms of getting lead times normalized or getting subcomponents in the door or anything like that that could affect the remainder of the fiscal year that you see at this point in time?

Shawn, I think that's a fair question. Given how the last couple of quarters of our fiscal 2017, we were down in the 18% range for transportation and we had talked about some of the supply chain issues. Largely, those issues are behind us. The team has done a nice job working through even at these higher volumes some of those issues. As we guided, we would be up in the 19% range for those Transportation segment numbers, and we certainly exceeded our own expectations.

Got you. Good to hear. As my follow-up, just thinking about the margin impact on SubCom and maybe what happens in a couple of quarters out. It looks like, year-over-year, it may have cost you 150-200 basis points given the program delays. Do you get an outsized margin benefit because of program completion accounting, maybe in the fourth fiscal quarter? Does it normalize out by whatever drag you saw this quarter?

Listen, we don't have enough time on this call to take everyone through purchase price accounting and project accounting in terms of the percentage of completion. It has its own levels of complexity. What I would tell you is, you should expect the next couple of quarters to look somewhat like this last quarter from a margin perspective, having that low double digits as the issue, albeit behind us; operational matters will bleed over due to the elements of the contract. It won't surprise us, as we get towards the end of some of the things, as well as new contracts that kick in, that you would see a quarter that would be higher than what we would expect. Sometimes, Terrence will refer to the SubCom margins as an EKG machine because they can move around relative to how the percentage of completion accounting works. Having said that, the true economics of the business are still quite solid.

Very fair. Thanks again.

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

Hi, good morning, everyone.

Hi, David.

So, if we take a look at the orders, the 11% increase in orders, 13% organically, and 13% in Transportation, it seems like there are a couple of things at play here. Because of the portfolio and the global nature, you're getting more opportunities to bid on things. I'm guessing your win rate is probably a little better and the programs are a bit larger. Are there any examples that you can share to flesh that out a little bit?

David, certainly. When you take our business, it's a lot of small projects. There isn't any one big program. What you're seeing is, like many companies, we have synchronous global growth, which is benefiting orders. But I wouldn't say there was any one big order outside of SubCom. What we are doing, around factory automation, we continue to see those trends, as well as medical momentum. It’s very broadly based.

What about as it relates to the win rate and the size of the opportunities that you are pursuing or winning?

I wouldn't say the size of the opportunities are changing dramatically. I would say the take-up rates are a little bit heavier as we're seeing volumes stronger. While we see some of the programs that we've won are well aligned to this growth. When you look at the orders, they are programs that were won three, four, five years ago, not as current other than SubCom.

All right, great. Heath, just one thing to follow up on the taxes. Are there any high-level views—though it's pretty complicated—on puts and takes on the taxes and your view of 2018 under the new rules versus the old law?

As I said in my prepared remarks, we guided a tax rate—an effective tax rate of 19% to 20%—here at the beginning of the year. I would say we are trending towards the bottom end of that. Some elements are attributable to changes in US policy and some are jurisdictional mixes. Overall, we had about a $500 million write-down of our deferred tax assets in the quarter, which is a non-cash charge related to our assets on our balance sheet for the new tax rate relative to certain interest deductibility.

Okay, perfect. Thank you very much.

Thanks, David.

Alright. Thanks, David. Can we have the next question, please?

Yes, thanks. Terrence, I just wanted to follow up on your comments on EVs, and appreciate the context. It's still a small unit market today. At the same time, you're seeing just a swell of investment from OEMs committing capital to that market. So, just trying to gauge from you, as you look out over the next one, two, three years, how you are seeing that play out in terms of kind of a linear progression or potential step function up in EVs.

What we get excited about is where we're positioned. When we sit there and we talk to many of you about our view on EV and plug-in hybrids, we see that as about 4 million units today. We expect that, over the next five years, it will get up to about 16 million units. I don’t think it will be linear. You get into how do governments support it, and social adoption will play a role. We see that diesel is not as favorable, and EV has come much more to the forefront. You see it with all of our global OEM customers that they're focused on both the autonomous trends and electric vehicle trends. Fortunately, both trends impact us, and we're positioned to capitalize on them. Our momentum and wins that we shared with you are helping advance our position and while it's still a small part of our business, it's going to be a significant growth driver as we go forward.

Got it. And just as my follow-up, maybe taking the other side on the order strength and understanding the global growth and the backdrop supporting that. At this point in the cycle, there are also rumblings that things are tightening and some lead times could extend. So, just your sense from a customer inventory perspective and distribution inventory and how you're seeing customers behave relative to other cycles.

Craig, it's a great question. We're getting some of the benefit as supply chains are catching up. So, that's where we see it. It would be around those markets. As we get into the second half of the year, we expect some of those markets to moderate, with a view of some of that tightness working out. When we look at our channel partners, they've been staying pretty stable. Their sell-out and our sell-in, their point of sale, and our point of purchase are pretty much in line. Our point of sale is out and point of purchase is in. So, we look at the inventory in the channel being balanced.

Got it. Appreciate the color.

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

Hi, this is Deepa Raghavan from Wells Fargo Securities.

Hi, Deepa.

Hi. How are you? Pretty strong automotive trends. It looks like, especially, you're benefitting from trend acceleration across the board. Could you talk about, if some of the trends—example, auto safety or EVs—are fully autonomous applications that the OEMs seem to be adopting much faster than expected? Will any of these trends benefit you more than the others, or is the content similar across these new trends?

Number one, both those trends will impact us. Autonomous trends necessitate high speed, and this is where we see our advantage in the connectivity needed. We did Hirschmann to support that. Both EV and autonomous trends provide a wealth of opportunity for us, as we shared with you at Investor Day. We are well-positioned as these trends unfold.

Got it. Sensors are pretty strong among others, obviously. Are some of these new automotive or commercial truck wins coming in slightly earlier than you would have expected?

No, they are not. When you think about automotive or commercial truck programs, when you win those programs, especially in automotive, they come in with the program launches. Automotive OEMs are very methodical about their program launches and quality checks. So, the growth we saw was in line with the timing we expected.

Okay. My final question: Communications segment. Would your data and devices division benefit from the 5G or FirstNet rollout? If they do, could you talk about the timing for that? It looks like, more towards 2019 driven, but just curious.

On 5G, we've been talking a lot about data center and cloud. In wireless, the next big step function is 5G. I do believe your timing is correct: 2019 and beyond will benefit our D&D business. The ramp is there for cloud and higher speed in our offerings, and while the market trend is strong, it hasn’t kicked in yet.

Thank you very much for the questions.

Thanks. Good morning. Terrence, you were talking about growth in commercial transportation and seeing some upcoming catalysts, including agriculture and other markets. You're looking at five or six quarters of double-digit growth year-over-year here. What is your sense of the cycle here, and are you seeing just as you are in automotive, a multi-year content growth story within that sector?

First off, yes. The content growth story is the same trends we have gotten in automotive and we're taking them over to Industrial Transportation. The content trends we have in that market reflect tightly. While we thought the heavy truck market would slow down in China this year, it has, as we thought. But what's nice is that other areas not contributing strongly—construction and agriculture—are beginning to kick in, which is also driving market trends and content wins. We feel good; it’s better than we expected, due to these developments. Our team has done a tremendous job not only securing content, but satisfying customers while maintaining a high growth rate.

That's helpful. And is that sensor growth that you're seeing also dovetailing off the commercial side of things?

Yes, we did. As I said, we saw double-digit growth in the commercial transportation piece of our sensor business as well.

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

Hi, good morning. One question and one confirmation. Just to clarify on the sensor business, you're still looking at a strong pipeline that starts to ramp, to be more so than you've seen in the last year or so, is that correct?

In automotive, that sounds accurate. The automotive programs will get stronger through the year and that is what we are seeing.

Okay. My question is about the industrial side; you've got about a $2 billion rough revenue business in industrial and the organic growth is up 17%. I was wondering if you can decompose that and how much would you attribute to better trends versus content?

When you sit there, there are a couple of things. You have both medical in there and industrial. When you look at those two—factory automation and medical continue to show strong performance. In industrial, we are seeing growth in factory automation globally, strong in Europe and the Americas, and sizeably so in China. The strong global growth is lifting that segment as well as content gains that are significant contributors.

Understood. Thanks for your help.

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

Thanks. I have two pretty short questions, so I'll ask them at the same time. On the automotive content growth, and now at the higher end of historical, given the long lead times in models and visibility you have, is it better to say that we're probably at a stage where it's at that high-end or even higher going forward? My follow-up question is on undersea telecom. We continue to see more contracts awarded and deployed, yet, you had challenges. Was that due to weather or not being able to get components as it seems like backlogs are taking longer than expected? Do you have visibility on that being right-sized to where it should be?

Let me take the second one; it's not weather. It was not impacted from components. It was a new project ramp that took us longer to manufacture it within our shop. It's a big complicated project with new technology. It just took us longer to get the system up and running. That impacted us, but overall, the cycle is very strong. When you look at the backlog we booked and the orders year-to-date of $400 million (compared to $500 million for the year last year), that shows the cycle is healthy and it's prolonged. We see programs that we want out through 2021, so we do feel the cycle is as we highlighted during Investor Day. The project ramp has resolved, but we do have lumpiness due to project accounting.

Thank you so much for the details.

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

Great. Thanks for taking my question and congrats on strong results and outlook. The one question I have relates to your more robust view on auto production for the year. As we all know, China is becoming a more important factor in that forecast, and there were some tax incentives that were in place. Half of it rolled off about a year ago and more of it rolling off now. Can you bring us up to date about what's happening with the incentives in China and how that is affecting your business?

Actually, the incentives, we spent a lot of time last year talking about them, and those incentives are over in China. We've seen the car OEMs get a little bit more aggressive in pricing rather than waiting for a government incentive, which is a more traditional behavior in the Western world compared to China's experience. As we think about auto production globally this year, we expect a total growth of about 3%, with Asia (including China) expected to follow suit.

It's very helpful. Thank you.

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

Hi, thank you. I just have a big picture question about margins. If you look at the first quarter, very strong margin performance, helped by the automotive—Transportation segment and the Industrial segment. But it seems like, looking at full-year guidance, you’re suggesting some moderation. I think there was commentary about that as well. So, somewhere in the middle of your 30 to 80 basis point improvement is where I think the full-year numbers are coming out. I guess my question is, do you expect some moderation in margins if we had a better-than-expected margin performance this quarter versus what you expect going forward? And as part of that, do you think that maybe some of your second half assumptions for margins are conservative?

Sherri, this is Heath. I would say that we came out of the year on all cylinders from a margin perspective, and we feel good about the performance. We would expect the margins in the Transportation segment to moderate, closer to the more normalized number, around the 20% range. We still expect nice year-over-year margin expansion in that segment. Same with the Industrial side. I would say Industrial is probably a little high in the quarter. Overall, we feel good about the orders and there's nothing in our guidance assumption that assumes big costs or major mix change, but we're taking a normal and cautionary approach. We’ll update everyone every 90 days.

Thanks.

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

Yes, good morning. Thanks for the opportunity to ask the question, and congratulations on the good quarter. I'll keep it to one question. On SG&A, I think the SG&A percent at 10.9% is the lowest in about 10 years. Very nice job on the SG&A line. How should we think about that item going forward? I think it was 12.1% in 2017. Are these SG&A savings something that can be sustained, or should we see an increase? Any sort of color on the ratio for fiscal 2018 would be helpful.

Sure. Mark, this is Heath. I think, again, similar to Sherri's question, we had some normal seasonality with that as well. I think that's a little low from a modeling perspective for fiscal 2018 at 10.9%. But certainly, we do have a goal of moving our operating expenses—including SG&A—closer to 16%, while protecting our R&D and raw engineering spend within that. So, you will see progress towards that. I would think modeling it that low for the rest of the year is probably a little aggressive.

Thank you.

Okay, thank you, Mark. It looks like we have no further questions. So, I would like to thank everybody for joining us on the call this morning. If you've got any follow-up questions, please contact investor relations at TE. Thank you, and have a nice day.

Thank you, everybody.