TE Connectivity plc (TEL) — Q1 2021 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 Chief Executive Officer, Terrence Curtin; and Chief Financial Officer, Heath Mitts. During this call, we will be providing certain forward-looking information and we ask you to review the forward-looking cautionary statements included in today's press release. In addition, we will use certain non-GAAP measures in our discussion this morning and we ask you to review the sections of our press release and the accompanying slide presentation that address the use of these items. The press release and related tables along with the slide presentation can be found on the Investor Relations portion of our website at te.com. Due to the large number of participants on the Q&A portion of today's call, we're asking everyone to limit themselves to one question to make sure we can give everyone an opportunity to ask questions during the allotted time. We are willing to take follow-up questions but ask that you rejoin the queue if you have a second question. Now let me turn the call over to Terrence for opening comments.

Thanks Sujal, and thank you everyone for joining us today to cover our results for our first fiscal quarter and also our expectations for our second fiscal quarter of 2021. Before I get into the slides, I would like to share some perspective on our first quarter. As you will see in the results, we are benefiting from our diverse portfolio and are continuing to execute on our margin expansion plans. While markets have been very dynamic over the past year, we are seeing improving conditions across the majority of them. Against this backdrop, we are demonstrating not only the resiliency of our operations, but also the ability to drive organic content growth ahead of our markets whilst expanding operating margins and demonstrating strong free cash flow generation that is in line with our business model. We are positioned to continue to benefit from secular trends and growing markets while driving the margin expansion plans that we've highlighted to you, and you'll see the benefit of these efforts in our first quarter results, as well as our guidance for the second quarter. With that as a quick backdrop let me now frame out some of the key messages of today's call. First, I am very pleased with our execution in the first quarter and I believe our teams delivered strong results. We delivered sales growth of 11% and adjusted earnings per share growth of 21% year-over-year, demonstrating the strength and diversity of the portfolio and the benefits from our operational improvements. Our sales were ahead of our expectations in each segment, but with the greatest outperformance in transportation, where we continue to generate strong content growth from electrification of the powertrain as well as increased data in the vehicle. Our adjusted operating margins expanded 190 basis points year-over-year to 17.7%, with margin growth in both transportation and our communications segment and a slight decline in our industrial segment where we maintain mid-teens margin performance despite a sales decline. We continue to demonstrate our strong cash generation model with our quarter one free cash flow being at a first quarter record of approximately $530 million. We continue to expect approximately 100% free cash flow conversion to adjusted net income for this fiscal year. And as we look to our second quarter, we are expecting our strong performance to continue. We expect sales and adjusted earnings per share, similar to the first quarter at approximately $3.5 billion of revenue and a $1.47 in earnings per share. And like in the first quarter, we again expect double-digit sales and adjusted earnings per share growth year-over-year. Now, I'd like to take a moment to discuss our performance relative to where our markets were in the pre-COVID timeframe of our fiscal 2019. And we do hope this will provide a baseline for evaluating our performance and progress this year. At the overall company level, our revenue is approximately back to pre-COVID levels, despite the majority of our markets being below 2019 levels and I'd like to give you some color by the three different segments. In our communications segment, we have seen strong improvement in our end markets and this has helped enable sales to recover above pre-COVID levels and for example, in Data & Devices as well as in appliances, we're benefiting from continued data center build outs and home investments respectively. In our industrial segment, it is a very different environment. We have markets that continue to remain weak as a result of COVID impacts, commercial air, and medical markets and our sales are still well below pre-COVID levels. However, what we are seeing is it does look like order patterns are indicating that we could be touching along the bottom in both of these businesses and we could see some improvements later in the year. And in our transportation segment our auto and commercial transportation businesses are now generating revenue above the levels we saw prior to COVID even though global auto and truck production is still forecasted to be below fiscal 2019 levels. Content growth and share gains have driven the outperformance, reflecting our leadership position in these markets. TE products and technology are designed in the next generation of sustainable vehicles at every leading OEM worldwide. The real proof of the traction is our content per vehicle progression. In fiscal 2019, our content per vehicle in auto was in the low 60s and it's now trending into the low 70s range. As consumer adoption increases for hybrid and electric vehicles and we continue to bring more innovation to our customers, we expect our content per vehicle to expand into the 80s over time. What's surprising is consumer preference continues to drive the features and the technology and we will continue to benefit as vehicles become safer, greener, and more connected, driving more content for connector and sensing solutions. While I am pleased with our results and the progress that we've made operationally, I'm even more excited about the sales growth and margin expansion opportunities that we still have ahead of us. We continue to execute on our margin expansion plans in transportation and industrial that we started prior to COVID and accelerated during the pandemic. I'm also very proud of the margin progression in communications, which has offset the volume-related pressure that we're seeing in industrial as a result of the market impacts due to COVID. So now if we could turn to the slides and I'd ask you to turn to Slide 3 to provide some additional details for the first quarter and our expectation for the second quarter. Quarter one sales of $3.5 billion were better than our expectations, up 11% on a reported basis and 6% organically year-over-year. We had 12% organic growth in both transportation and in communications with growth across all businesses in those two segments. Industrial segment sales were down 8% organically due to the COVID related impacts I already talked about. During the quarter, we saw orders of $4 billion and this was up 25% year-over-year, reflecting an improvement in the majority of the end markets we served and I'll come back to orders in a couple of slides. From an earnings per share perspective our adjusted earnings per share was $1.47. This was up 21% year-over-year. It is a strong operational performance where we showed adjusted operating income being up approximately 25% year-over-year. As we look forward, we expect our strong performance to continue into our second quarter with sales and adjusted earnings per share being similar to first quarter levels, despite lower sequential auto production. For the second quarter, we expect sales to be approximately $3.5 billion and this is up approximately 10% year-over-year on a reported basis and mid-single-digits organically. Similar to our first quarter, year-over-year growth will be driven by transportation and communications, partially offset by an organic decline in industrial. Adjusted earnings per share is expected to be approximately $1.47 in the second quarter and this will be up 14% year-over-year with adjusted operating margin expansion included in the earnings performance. So if you could let me turn to Slide 4 and I'll get into order trends that we're seeing. For the first quarter, our orders were approximately $4 billion with a book-to-bill of 1.15. I would like to highlight that this level of orders reflects improvements in a number of our end markets as well as some supply chain replenishment. As we see markets improving, it is not surprising that our orders reflect the impact of supply chains being replenished after the shutdowns that occurred in the U.S. and Europe in the third quarter of last year. We are also seeing customers placing advanced orders in some cases due to product constraints and the broader electronic component categories like semiconductors and certain passive components. And the guidance that we give does factor in the impacts of these supply chain dynamics. And looking at orders by segment, on a year-over-year basis, transportation and communication orders both grew 36% with broad-based growth across all businesses. Industrial orders declined slightly year-over-year but on a sequential basis, we did see orders grow in all businesses in each segment. So let me also add some color on what we're seeing in orders from a geographic perspective and I'll provide this on an organic basis. In China our orders were up 33% in the first quarter, with growth driven by transportation and communications. We are benefiting from our strong position in auto, commercial transportation, and appliances and continue to see strong improvement across those markets in China. We also saw 26% year-over-year growth in Europe with growth in all segments. This represents a second consecutive quarter of orders growth in Europe, with some markets improving following the large drops from COVID back in the middle of last year. And in North America, our orders were flat with growth and transportation and communications being offset by declines in industrial. Now, what I'd like to do is touch upon our segment results briefly and I'll cover those on Slide 5 through 7. Starting with transportation, our sales were up 12% organically year-over-year with growth in each one of our businesses. In auto, sales were up 11% organically versus global auto production growth in the low single digits. The outperformance is driven by continued strong content growth and some benefit from the supply chain replenishing. We are seeing gains from our leadership position in next generation products and technology and the value that we bring to our customers. As I mentioned earlier, we are seeing strong content growth from the move to an electric powertrain and increased data connectivity, as well as the continued electrification of the vehicle. In our commercial transportation business, we saw 25% organic growth driven by electronification trends which are helping content outperformance as well as ongoing share gains. We are also benefiting from higher emission standards and new increased operator adoption of Euro 5 and 6 in China and new emission standards in India. We saw growth in all regions, as well as all market verticals that we serve in our commercial transportation business and continue to benefit from our strong position in China. We are also seeing increased program wins in the electric powertrain and commercial transportation that will provide future content growth. In sensors, we saw 29% growth on a reported basis, which included the revenue contribution from the First Sensor acquisition. On an organic basis, sales increased 3%, driven by growth in auto applications. And we continue to expand our design win pipeline in auto sensing and expect growth of these platforms to continue to increase in volume. From an operating margin perspective, the segment expanded margins by 200 basis points to 19.4%, driven by strong operational performance. Now, let me move over to the industrial segment where, as I mentioned, our sales declined 8% organically year-over-year and our adjusted operating margins were down slightly to 13.5%, despite the 8% organic sales decline. I am very proud we were able to maintain our mid-teens adjusted operating margins due to the cost actions that we initiated over the past couple of years. During the quarter, the segment continued to be impacted by the decline in the commercial aerospace market, with our AD&M business declining 22% organically. As I mentioned earlier, we do believe we're touching along the bottom in this business and could see improvement in Comm Air later in this year. Our industrial equipment business was up 8% organically with growth in all regions and strength in factory automation applications. And we continue to see weakness in our medical business with ongoing delays and interventional elective procedures that have been caused by COVID. We anticipate this to be a short-term dynamic in medical that is consistent with what our customers are saying and expect this market to return to growth as these procedures start to increase later in the year. And lastly, in our energy business, we saw a 4% organic decline driven by COVID impact on utility spending but we did see growth in renewable energy applications and the wind and solar applications. Now let me turn to the communications segment where our sales grew 12% organically year-over-year with growth in both Data & Devices as well as appliances. We continue to benefit from the recovery in China and Asia more broadly, which represents over half of our sales in the segment. In Data & Devices, our sales grew 5% organically year-over-year due to the strong position we built in high-speed solutions for cloud applications and in appliances, we grew 21% organically year-over-year with growth across all regions and benefits from home investments and an improved housing market. I would have to say our communication team continues to perform very well delivering 17.6% adjusted operating margins, which is up 550 basis points versus the prior year.

Thank you, Terrence and good morning everyone. Please turn to Slide 8, where I will provide more details on the Q1 financials. Adjusted operating income was $624 million, approximately 25% year-over-year, with an adjusted operating margin of 17.7%. GAAP operating income was $448 million and included $167 million of restructuring and other charges and $9 million of acquisition-related charges. We plan for the restructuring to be front end loaded this year and continue to expect total restructuring charges in the ballpark of $200 million for fiscal 2021 as we continue to optimize our manufacturing footprint and improve the fixed cost structure of the organization. Adjusted EPS was $1.47 and GAAP EPS was $1.13 for the quarter and included a tax-related benefit of $0.09. We also had restructuring, acquisition, and other charges of $0.43, that reconciliation has provided. The adjusted effective tax rate in Q1 was approximately 20%. For the second quarter, we expect our tax rate to be in the high teens and continue to expect an effective tax rate of around 19% for fiscal 2021. Importantly, we expect our cash tax rate to stay well below our reported ETR for the full year. So if you'll turn to Slide 9. Sales of $3.5 billion were up 11% on a reported basis and up 6% on an organic basis year-over-year. Currency exchange rates positively impacted sales by $106 million versus the prior year. We are demonstrating our business model execution with adjusted EPS of $1.47, up 21% year-over-year. Adjusted operating margins were 17.7% as I mentioned earlier, and that is an expansion of 190 basis points versus the prior year. I am pleased with the progress we are making in driving improvements to our cost structure and our strong operational performance. And we continue to execute on our footprint consolidation and cost reduction plans in both transportation and industrial. We are now benefiting from the heavy lifting that we've already completed in our communications segment. Transportation adjusted operating margin was 19.4%, which is nearing our business model target of 20%. Industrial adjusted operating margins remained in the mid-teens despite significant volume drops, which demonstrates the benefits of our cost actions we have been discussing with you over the past few years. I'm also very pleased with the 17.6% adjusted operating margin in communication, which reflects our strong operational execution that I mentioned earlier. In the quarter, cash from continuing operations was $640 million, and we have very strong cash flow for the quarter of approximately $530 million, which represents a first-quarter record as Terrence mentioned. And we returned $286 million to shareholders through dividends and share repurchases. Our strong cash flow performance last year and into the first quarter of this year demonstrates the strength of our cash generation model and we continue to expect free cash flow conversion to approximate 100% for the full year. We remain committed to our disciplined use of cash and over time we expect two-thirds of our free cash flow to be returned to shareholders and about a third to be used for acquisitions. And before we go on to questions, I want to reiterate that we remain excited about how we positioned our portfolio with leadership positions in the markets we serve, along with organic growth and margin expansion opportunities ahead of us. To summarize, we have discussed the benefits of secular trends across our portfolio. You are seeing content growth enabling sales performance above our markets in auto and commercial transportation, benefits from market recovery in Data & Devices and appliances and some markets that have been impacted by COVID in the industrial segment that are now showing signs of stabilization. We initiated cost actions well ahead of the COVID downturn and we're seeing strong margin expansion as a result of our efforts. We expect to continue to generate strong cash flow, maintain a disciplined and balanced capital strategy and drive to business model performance, our focus on value creation for our stakeholders going forward. So now let's open this up for questions. Sujal, Sherryl could you please give the instructions for the Q&A session.

Yes, thank you and Terrence, thanks for the color on the current supply chain dynamic. If you can just expand on that, I know there's plenty of news around kind of bottlenecks out there, you mentioned semiconductors, just kind of a gauge of how you would frame what you're seeing in your business versus the demand out there and where we are in this kind of replenishment phase?

Hey, thanks Craig. And I would say, first of all, I think like many things COVID, the recovery is very uneven and it's impacting different businesses differently. So, the comments I made were very much around transportation. And markets that are soft like industrial, I would tell you we still have in places like medical and aerospace inventory still being burned. So I do think the factors impacting supply chain are very similar to how we painted the overall picture of the three segments. I think when you look at the supply chain, you go to transportation though, I think we ought to keep in perspective where auto production went to and how automotive is adjusting in time supply chain. So back in the third quarter, 12 million units were made that we made 22 million units on the planet, I think was quicker than we all would have thought the recovery was. And there will be some areas where there will be bottlenecks as everybody recovers. And, you heard that and certainly our customers have adjusted some of their production due to that and that's reflected in our guidance. But what's nice is on top of that, even though we're talking about supply chain is, where consumer inventory levels are very healthy. So when I think about what we try to track for long-term or how many cars are being bought on the planet, it's nice to see inventory levels on the lots. When you look at North America and China, probably being more towards middle to low end of normal ranges, Europe’s probably right around the middle. And, it's not surprising that the supply chain is being stretched a little bit due to the improving markets we're seeing. And some of our customers have adjusted their production, and that's in our guidance.

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

Hi, sorry, I will stick to one question and I want to say congrats on some really good execution in the last six months with the way demand has recovered. I guess the question I have is when I look at the December quarter print and the March quarter guide, especially transportation up really strong and better than end unit production, I think the fewer folks will have is that, a strong first half, fiscal first half for you folks could be over shipping versus end demand and OEMs are just building a lot more inventory than they need. And, the risk would eventually be that in the back half of the year, your fiscal year back half ends up being a lot softer as OEMs start to normalize inventory. Could you just perhaps talk about what are you seeing from the OEM level that gives you confidence that this isn't overbuilding of inventory and there's a correction in the back half that we have to worry about?

I think the thing that you look at is certainly we have orders that are accelerating to the improving market. Supply chain does need to get to a normalized level where production is. I think when you look at auto production going from quarter one to quarter two, we do expect it to be down to about 20 million units in our second quarter versus 22 in the first quarter. So, that should also allow the supply chain to help normalize since there will be a little bit less production. And when we look at it, what's really nice is our growth is doing more to content and production than it is due to the supply chain replenishment. As we've always told you, in an individual quarter, you can get supply chain movement one way or the other. But when I think about content per vehicle, as I said on the call and really think about the $10 or so that our contents increased over the past couple of years, really about half of that is driven due to traditional electronification of the core being more electronics and the other half is being driven by the benefit of the wins we have in EMs as well as, I'm sorry, electric mobility, as well as what we've gained in content on the car having more data. So when we look at that, that's real content growth. Certainly in the quarter there may be a little bit of movement as supply chain goes, but the bigger driver of our growth is content and that's what's really allowed our transportation segment to get back to pre-COVID levels. And what we all know will be production this year based upon the external estimates will be less than pre-COVID.

Okay, thank you Amit. Could we have the next question, please.

Hi, good morning Terrence and Heath and appreciate you taking my question. Maybe just following up on that point and just to be clear, when you're talking about the buckets and the drivers of that content per vehicle ramp, was that in regard to the shift you've seen the low 60s to the low 70s? And just as a follow up, as we start thinking about the go forward drivers to that low $80 target, just curious, what percentage of that or the mix shift driver you expect from the electrification and EB trends specifically?

I believe we will see a balance as we move into the 80s, similar to what we've experienced before. One important observation is that electric vehicles have proven resilient through COVID. Last year, we noted growth in electric vehicles, and this year, we expect a 50% increase in the number of electric vehicles worldwide compared to last year. There is continued strong adoption in Europe, and Asia has already made significant strides, which will help surpass 10% of global production. Our position in electric vehicles will continue to benefit from this growth, but we should also acknowledge the ongoing opportunities in traditional architectures, which also contribute to electric vehicles. The transition from 60 to 70 will look very similar as we progress because our products are involved in all types of vehicles. Our legacy strength globally enhances our position. Looking ahead, all components—whether related to electric vehicle powertrains, vehicle electronification features, or data capabilities—will drive our content growth. Recent years have shown us the reality of this, and it excites us as we anticipate future growth.

Okay, thank you David. Could we have the next question, please.

Yes, thanks and good morning. Terrence I wanted to ask outside of transportation, the commentary on industrial, particularly the areas that you're seeing strength. How much of that is relative to supply chain inventory adjustments versus true demand and I know there's a decent amount of distribution exposure there. Are you seeing signs of good POS or sell through and any inventory build there?

Thank you for your question, Matt. When considering distribution, it impacts both our CS and IS segments—industrial and communications—more than it does transportation. Our sales into the channel this quarter matched our overall company sales growth of 6%. The sell-out from our channel partners has picked up due to some supply chain dynamics, which is why they maintain inventory. While we've noticed an increase in some of their orders, we haven't over-shipped to our distributors. In fact, their inventory levels are currently lower than usual. As the market stabilizes, there will be some balancing to take place. Regarding the industrial sector, although we see strengths in areas like industrial equipment, I should note that our medical customers are still reducing their inventory, as are those in aerospace and defense. Overall, I wouldn't characterize this as a supply chain replenishment in industrial that we are benefiting from.

Okay, thank you Matt. Could we have the next question please.

Thank you. Good morning. It seems that over the last couple of years, your CPV might be slightly above your long-term range, similar to what we observed from 2017 to 2019. Is that range protected in any way, or does it indicate that your commercial team is performing better in securing wins, or is it related to the types of vehicles consumers are purchasing?

The range for CPV has always been stated as 4% to 6%, and I believe this range remains suitable for the long term. There are factors to consider, such as electric vehicle adoption and feature offerings. We are confident in that range and do not restrict our commercial teams to it. Ultimately, consumer preference plays a role, and it's encouraging that consumers are increasingly embracing the features we provide. We are optimistic about maintaining that 4% to 6% range above auto production moving forward, and I doubt that range will change. Ideally, we will stay closer to the higher end of it.

Okay, thank you Chris. Could we have the next question.

Great. Good morning, guys.

Hey, Scott.

It's great to hear from you, and I hope you're doing well. I wanted to check in for an update on First Sensor and see what your initial impressions are. Any details you could share would be appreciated.

Sure, thanks, Scott. This is Heath, and I appreciate the question. We still own a little over 70% of First Sensor. Due to the dynamics of the German public company takeover, there's still some time involved in acquiring the remaining 25 to 30 percent of the business from the current owners. However, First Sensor is performing as expected, with significant market overlap in sectors such as automotive, general industry, and medical applications. The performance aligns with our expectations based on what we see in other aspects of our sensor and connected businesses. Currently, it contributes around $40 million to $50 million in revenue each quarter. We are continuing to work on operational synergies and consolidating our facilities, not only on their side but also by incorporating elements from our existing sensors business into their operations. Therefore, we do not anticipate much support for our bottom line this year, but the trajectory still looks promising as we move ahead.

Alright, thank you Scott. Could we have the next question, please.

Hey, this is Danielle asking on behalf of Wamsi. Can you just talk about kind of your position in the broader electric vehicle market and kind of key differentiators for key?

Thank you. One of our key differentiators is our global presence and innovation capabilities, starting with our numerous design centers. These centers are involved in the design of both current and next-generation vehicles, which is quite unique. We have capitalized on our established expertise. Additionally, our understanding of vehicle architecture spans both traditional and electric vehicles, especially in how components like powertrains and batteries integrate. It's important to note that vehicle architecture unites low voltage and high voltage systems, which ties into infotainment and data, leading towards autonomy. TE occupies a distinctive position in this space, which enhances our opportunities for content. We've been investing in electric vehicle technology for the past decade and anticipate around 9 million electric vehicles will be produced this year, with 5 million of those in Asia. Europe is also advancing, and we're particularly enthusiastic about not just the vehicle technology but also the support needed to bolster electric vehicle adoption. Consumer acceptance is key, but we also need to consider infrastructure and battery technology, where we’re seeing ongoing developments. This global progress will drive continued momentum for electric vehicle adoption and enhance infrastructure and battery innovations. Initially, we were optimistic about Asia and Europe, especially with regulatory factors, while we also see positive trends here, albeit at a slower pace. TE's role in integrating architecture—combining electric systems, data, and signals—is our expertise, and we believe these trends will yield significant benefits, as reflected in our content numbers.

Okay, thank you Danielle. Could we have the next question, please.

Hi, good morning. Thanks for taking my question. I did want to go back to the content growth story again in autos and just focus a bit more on the sensor side of the business there. You kind of outlined $10 of content increase you have had over the kind of moving to $70 range, low 70s. Can I just clarify if that includes sensors at all or is it de minimus at this point and more kind of looking forward how should we think about the opportunity in terms of sensors that you can address today on a vehicle and what the aspirations are for what that content per vehicle for the sensors portfolio can look like?

Thank you, Samik. The figures I mentioned earlier did not account for sensors; they were solely related to our traditional interconnect solutions. If we look back to 2019, sensors contributed about $2 of content, and we expect that to rise to around $5. This increase would be in addition to the previous figures I provided. The auto launch has driven our organic growth, and our sensor business still has a significant industrial segment that influenced those numbers. However, the sensor portion will add to the figures I mentioned earlier.

Okay, thank you Samik. Could we have the next question, please.

Yes, good morning and thanks very much for taking the question. Good morning. You talked a lot about some of the near-term dynamics in the first half of the year and sort of the nice strength and recovery you're seeing. So I can better understand your thinking not just the second half outlook, but what you're thinking about investing in the business longer term in terms of where you're deploying capital, in terms of these acquisitions like for sensors or some of the R&D you're doing to really capture that content growth you're seeing in EVs, what's most interesting to the company, what are you most excited about going forward?

So, thanks for that question. And I do appreciate it Mark. I think when you think about when we look forward, I think there's one that I'll talk about short-term and then there's one that I think are important longer-term. I do actually think this period over the past year and the dynamics and the challenges that we've all gone through, we're getting to show our portfolio, the diversity of it, and why we like our portfolio. And a lot of people had questions of how this portfolio would act because it wasn't the same portfolio. And we do like our portfolio and you see that here. I think the other thing as we look forward is the content elements we've talked to you about when you think about transportation, the content opportunities we're talking about are still in early stages and electric vehicle is an early stage, autonomies are early stage and that in many ways would content kickers we've been talking about and you're starting to see it in the numbers and they're going to be around for a while. But I would say it's not just limited to auto and transportation. You've seen how our communication segment has changed, certainly around our cloud investments and how we've gained share in cloud that has made that segment the performer. And when you think about industrial, medical will come back, Comm Air will come back and our positions are very strong. So there are things that are certainly they're hurting us now, but I think will be things that drive content longer in the future. And those are the things where data and power are going whether it's around sustainability as things being more connected, where things get more productive like factory automation, we still have content opportunity to drive growth that's going to be above market. The other thing I would just say, well, I'm pleased with the execution. Our margin improvement story is not over. Our transportation and our industrial segments we've been doing some heavy lifting to get to where we believe these businesses are entitled. It's nice to see our transportation segment on lower volume than peak being that close to the margin we think it should be at. But our industrial segment has room to go and, lastly I think it goes to the point that you sort of alluded to and your question is, we like our cash generating business model. It provides choices whether return capital or you do the bolt-ons like Scott's question to Heath around First Sensor and what's nice is we do have organic secular trends that we can do bolt-ons into. And we're going to maintain discipline as we go through it. So as we look forward, it's nice to see some improvement. We're always going to have a market that's probably cycling one way or the other with the diversity. But I do think with the portfolio showing up that we're pretty proud of, and we think there's more room to run on the growth on the margin side, which turns into earnings power and cash generation for value creation.

Alright, thank you, Mark. Could we have the next question, please.

Good morning. It's great to see the total content scaling from the 60s to 70s. I wanted to discuss the longer term. You've often mentioned that EVs generally have two times the value of regular cars. As we reach those critical points where EV production increases rapidly, what does the spread look like? How much of that spread is due to actual higher physical volumes in the cars, and how much is attributed to the significantly higher prices because the volumes are much lower? How does this change over time? Will prices decrease significantly while volumes increase so that gross dollars look very positive, but the gap between internal combustion engine and electric vehicles narrows? How should we think about this as we move towards significant EV deployment?

Well, a couple of things, and our content assumption always assume, I do think we have to keep in reality, an ICE vehicle. If you take this year where people think mid 80 million vehicles will be made in 2020 alone, there is 70 some million of ICE vehicles made versus 9 million of electric vehicles made. So there is a scale advantage. Certainly our customers expect that and we do expect there will be price compression in our content as EV scale. We also have to make sure we bring our technology and our scale to make sure these vehicles are affordable. And so that's always been included. You will still have increased content. So I don't think you see it getting to an ICE engine content, but there will be some as you move up the volume curve on platforms and as the industry scales and we've always said that to you. So, that's how we've always said it and then we don't see that changing and it's something that's very important for the industry to make sure electric vehicles are on par with traditional engine so that consumers can choose what they want.

Okay, thank you, Joe. Could we have the next question, please.

Thank you for the time. Just another one on the content per vehicle and then particularly comments that CPV is in the low 70s today versus the low 60s, I believe you said in 2019. So some quick back of the envelope math there implies high single digit annual growth. So I guess is there any reason why this growth rate would slow maybe over the next two years, I understand longer-term there can be more pricing competition as that builds but I guess over the next few years, is there any reason to think that would slow, obviously the number building off a higher base, but EV unit production is inflecting and it seems like there could also be some sensor tail into it as well?

The way we look at it, it goes back to what I said before, we think it's 4% to 6% above global production and that depending on what you assume on production grows from here. You would take the content and add to it. So I'm not sure it would slow. I mean, it will come into how consumer preferences are, but it's what we get excited about on content. So I don't see it slowing. I see it actually being a real engine for us and we've been investing around it and certainly we'd like to see that the revenue that's coming through on it we'll partner with our customers and we know we're solving their hardest challenges.

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

Thank you. Terrence, you mentioned a couple of times that you're excited about the margin progression opportunities. If we go all the way back to 2017 you laid out this 30 to 80 basis points a year, which, would have brought you close to 19%. Now I know a lot of outside factors have occurred since then, but you've also taken some other actions. So I'm just curious, do you have a view of the margin potential of this business looking out a few years, is the 19% to 20% range still to go?

Yeah, Jim this is Heath and I'll take that question. Yeah, the progression over time certainly is still part of our operating model and how we think about the go-forward. Certainly, we've had to deal with some things that were unexpected relative to market conditions, no different than any other company out there. But, we still feel like we're in a pretty good place. Now, acquisitions are always going to feather into a point where, you have to overcome some of that dilutive impact initially, and then you build upon that moving forward. But I still feel very good about it, but I think you've got to kind of break it down into the segments as well. The segments, we've kind of targeted and talked about automotive being roughly a 20% operating income business, which is a both, avails a good return from an overall investment as well as provides opportunity to enable, reinvestment of the business for future growth. And that's a good return model. Industrial, which is in the low teens as we sit here today, but coming off of a pretty significant downturn, particularly in the commercial aerospace side, as well as in the medical side is still holding its head. But we would expect that over time, again, to be up into the high teens. So there's a fair amount of leverage there. And then in communications, we're in a pretty good place. We've done a lot of heavy lifting there going back several years and you're seeing the results there now when we get the types of volume reduction or I'm sorry, the types of volume increases that we've seen both in appliances and Data & Devices. You can see what the flow through is in our factory environment with an optimized footprint that we enjoyed today within communications. So, there is still leverage in both transportation and in industrial. And in addition to that, we're still tackling some of the costs in the operating expense line that you would expect us to and that's been coming down ratably particularly as percentage of sales and that will continue to be the case. So feel good about our ability to continue to expand margins for some time now.

Alright, thank you, Joe. Could we have the next question, please.

Good morning. Heath, maybe another question for you, wondering if you could put this quarter's margin performance in context of the 20% mid-term margin target for transportation solutions specifically. Just wondering how this quarter’s profitability impacts that trajectory going forward, maybe thinking in LEB terms specifically what it says about the production needed that 20% margin target relative to maybe what you would have thought pre-COVID?

That's a good question. The 19.4% margin is a strong figure for that segment, but it's important to note that we are still performing below our levels from a couple of years ago in global auto production. This quarter, production was just over 22 million units, which is still behind the numbers we saw in 2018 and 2019. This shows our capability to operate effectively even with lower auto production compared to past challenges, thanks to our management of fixed costs. We're also undergoing some restructuring, particularly concerning our operations in Europe within the transportation segment, which is currently in progress. Some of these changes are experiencing pressure because we require more output from those facilities, but we expect to see greater advantages from these plans as we move through 2021 into 2022. Additionally, with the recovery we've seen—going from 12 million units in the June quarter to 22 million units in December—there's a significant increase in our capacity to scale. However, this rapid increase can lead to some inefficiencies. While we're happy with the margins, there is still potential for improvement.

Alright, thank you, Luke. Could we have the next question, please.

Thank you. My one question is on average selling prices, kind of looking ahead in the transportation segment. In the past I believe under conventional cars and autos, the price declines were kind of like 1% to 2%. Is that going to be similar as you look at more say battery connected HV cars that features similar percent or actually better percent declines or worse decline, the reason I ask is as you know, there's a lot of shortages in the automotive semiconductor industry and they're seeing better pricing declines and I know that you have more annual or longer term contracts, but I was kind of wondering longer term of that segment is the math formula of the 1% to 2% average price decline still intact or because these are newer technologies, they should actually decline faster or because they are newer technologies that could actually hold up better?

So again, a couple of things, thanks for the question. And I'll tie back to the question I got earlier. First off, when we look at pricing right now, we sort of view it as stable. Certainly, we don't make semiconductors so some of the shortages that are happening in that space we do. When you look longer term and that assume supply chain normalizes, we do expect our electric vehicle product portfolio to have a higher price curve just due to the volume. And that's something we've always said that's included in our 4% to 6%. And so depending upon how those volumes go and that's typically the arrangements that we have with our customers that are typically volume and we sit down and have those discussion with our customer. I would also tell you that when we think about content, we do expect content to be about 2X with EVs. And also the margin targets we give you also include that price on that Heath has talked about a few minutes ago. So net-net it will be a little bit higher as it scales in those product sets. But overall as part of our margin model and content model, we've always reviewed with you.

Alright, thank you Jim. Could we have the next question, please.

Great, thanks for taking my question. I'm hearing a louder chorus of voices talking about ECU consolidation as an aspect of the evolution of automotive networking architectures, things like domain architecture or some zonal architectures. Do you see this happening as well or is it more talk from some technology providers than sort of real action by the tier ones and OEMs, and also, I'm curious how you expect this will influence connector units, pricing and your current position with customers? Thank you.

This is not a new trend. There's a significant issue here regarding feature integration and electronic control units (ECUs). While cars have many ECUs, the focus should be on how we add features into an ECU rather than simply adding another box to the vehicle's architecture. This approach helps maintain control over the system's complexity. Although some may speculate about the possibility of a single mega ECU or two, I believe that's a distant idea. Incrementally, we see that the number of interconnects within these ECUs has become more complex, which benefits us. Additionally, the need to sense various activities within the car results in more connections. As I mentioned earlier about the content picture, about half of the $10 increase is related to electric powertrain content and data, while the other half stems from an increasingly complex low voltage architecture that incorporates more features. A connection is still necessary to link the feature back to a central unit. ECUs are evolving similarly to semiconductors, integrating more components on a chip. This evolution prompts more complex connection solutions, as these units must interface with various applications within the vehicle, which is advantageous for us. We believe that increased connections create more complexity, which our customers require for innovation. I hope this clarifies the issue and addresses your question.

Alright, thanks Will. Could we have the next question please.

Good morning, and thank you for the opportunity to ask a question. I would like to know more about the trends you are observing in the data center and how strong those trends are, along with your outlook for the year regarding these trends.

The data center market has remained unaffected by the COVID cycle, and this trend continues. We anticipate another double-digit increase in cloud and data center spending this year. Our Data & Devices units are experiencing growth in semiconductors, which supports this trend. Cloud spending is on the rise, and we are also seeing positive margin progression. Our engineers are effectively focused on where to enhance margins, and we are pleased with the market share we've gained among all cloud providers. The team deserves recognition for their efforts and innovation in serving these cloud providers.

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

Yeah, good morning. Thanks everyone. Terrence, I think I heard you talk about increased design wins in the electrification and the commercial transportation. I wonder if you can give us a little bit more color on that and maybe compare at what stage do you think that the EV in commercial transportation is relative to where EV and my vehicle is today, or maybe where light vehicle EV was a year or two years ago?

Thanks for the question, Nick. We've had extensive discussions about the automotive sector, particularly around electric vehicles, trucks, and advancements in last mile fleets. Over the past year, we've observed a substantial uptick in platform work from major commercial truck manufacturers. This increase appears to be more serious than previous exploratory projects. Our role in commercial transportation parallels our position in the automotive space; it’s a global endeavor and adaptable to various architectures, which is why we value being a tier two supplier. Looking at our team's work, we’re witnessing noticeable acceleration. The range of vehicles in commercial transportation, whether it’s mining or Class A trucks, is quite extensive, and we're enthusiastic about the content opportunities there. Currently, our program activity levels resemble where we were three to four years ago in automotive, indicating a similar momentum is developing now. We’re excited to leverage our position in a way akin to our success in automotive, which can enhance our content leverage in ICT.

Okay, thank you, Nik. It looks like there's no further questions. So if you have any questions, please contact investor relations at TE. Thank you for joining us and have a nice day.