TE Connectivity plc (TEL) — Q4 2022 Earnings Call Transcript

Good morning and thank you for joining our conference call to discuss TE Connectivity's fourth quarter and full year 2022 results. With me today are Chief Executive Officer, Terrence Curtin; and Chief Financial Officer, Heath Mitts. During this call, we will be providing certain forward-looking information, and we ask you to review the forward-looking cautionary statements included in today's press release. In addition, we will use certain non-GAAP measures in our discussion this morning and we ask you to review the sections of our press release and the accompanying slide presentation that address the use of these items. The press release and related tables, along with the slide presentation, can be found on the Investor Relations portion of our website at te.com. I also want to remind you that our Q4 results include an extra week and we'll be discussing some of our results on both the 14-week and 13-week basis during the call. Please see the appendix in the slide presentation for the impact of the extra week in our results as well as the accompanying reconciliations. Finally, during the Q&A portion of today’s call, we are asking everyone to limit themselves to one question and you may re-join the queue if you have a second question. Now, let me turn the call over to Terrence for opening comments.

Thank you, Sujal, and we appreciate everyone for joining us today. As I typically like to do at the beginning of these calls before we get into the slides, I'd like to spend some time discussing our performance, along with some of the developments that we're seeing since our call just 90 days ago. While there are a number of external data points showing crosscurrents from global economic uncertainty, we continue to perform well and you'll see this both in our fourth quarter and fiscal year 2022 results. Our performance came in ahead of our guidance and continues to demonstrate the benefits of how we strategically positioned our portfolio around secular growth trends as we continue to outperform our markets. We also demonstrated operational performance in serving our customers and delivering strong financial results despite the broader macro challenges. Our backlog remains near all-time high levels and our overall order levels imply solid demand across the majority of the markets we serve. Within this backdrop, we have some markets that are growing, some that are still in recovery mode back to pre-pandemic levels, and others that are showing signs of moderation. At the same time, we're being negatively impacted by a stronger dollar, which will continue to be a significant headwind into 2023. I also want to highlight that our team continues to proactively implement price increases to keep up with ongoing inflationary pressure. I am confident in our ability to execute in the short-term as we navigate these challenges and I am excited about the long-term opportunities as we go forward. Heath and I will go into more details on these moving pieces as we discuss our performance and outlook on the call. To summarize our financial performance, we delivered strong results again in the fourth quarter with double-digit organic growth and double-digit adjusted earnings per share growth year-over-year. For the full year, our adjusted sales and adjusted EPS were records with sales up 12% organically and adjusted earnings per share up 13% versus the prior year despite headwinds from foreign currency exchange and inflationary pressures. With this quick backdrop, let me give you some details on what we're experiencing. First, on the orders front. We're seeing some pulling through across the different end markets we serve; and this is reflected in our orders in our backlog. With the higher backlog levels that we have and the stability we're starting to see in our supply chain for the first time since COVID, it is reasonable to see our book-to-bill below one in the quarter. Our backlog remains strong at $6 billion, which is almost two times higher than pre-COVID levels. If you click down on orders by segment, transportation and industrial are continuing to show positive order trends. In transportation, OEM auto production is still constrained by supply chain limitations, and end demand remains above current levels of production. So, we continue to have a favorable outlook for this market long-term on both production as well as content growth. In the industrial segment, we continue to expect growth in commercial air and medical markets as reflected in our orders, along with the benefits from wind and solar applications in our energy business. Renewables now represent 20% of our energy sales and the commercial air market is still recovering to pre-COVID levels. And both of these will be growth areas within the industrial segment in 2023. In our communication segment, we are seeing orders decline in the appliance market. Based upon recent developments, we have seen orders to cloud customers moderate, reflecting lower capital spending along with inventory adjustments in the data center supply chain. We also continue to experience inflationary pressures and this is particularly true for resins that we use for molding, as well as higher energy costs that impact our manufacturing operations globally. We are continuing to implement additional price increases to offset these inflationary costs and expect to have a positive contribution margin later in 2023 from the price/cost dynamic. And the last thing I want to highlight before we turn to the slides and I think we've consistently demonstrated, we will take actions to ensure our cost structure is in line with what we're seeing in the market environment and Heath will provide additional details on this in his section. So, now let's get into the slides and I'd ask you to turn to slide three, and I'll cover some additional highlights for the fourth quarter in the full year as well as get into our first quarter outlook. As Sujal mentioned earlier, our fourth quarter included an extra week. Our fourth quarter sales were $4.4 billion, which are up 14% on a reported basis, our adjusted operating margins were 17.4%, and our adjusted earnings per share was $1.88, and this was up 11% year-over-year. If you include the extra week to get to a better apples-to-apples comparison, our fourth quarter sales were slightly over $4 billion and this was up 12% organically year-over-year, and adjusted earnings per share were $1.75. A key thing to highlight in the fourth quarter is that we delivered record free cash flow of $745 million in the quarter, which demonstrates our strong cash generation model and we returned over $500 million to shareholders. I do want to highlight and we discussed it with you previously, earlier in the year, we did increase inventory levels to deal with supply chain volatility and ensure we can meet the needs of our customers. As we began to see our supply chain improving, we decided to get our inventory more in line and reduce our inventory by approximately $350 million in the quarter and you'll see our days on hand were actually down year-on-year in the fourth quarter. We do believe this was prudent balance sheet management in the current environment and this action improved our free cash flow in the quarter, but does pressure our margin in the short term. So, now let me touch upon a few additional highlights for full-year results. Our fiscal 2022 results were record at $16.3 billion and this was up 9% year-over-year on a reported basis despite currency exchange headwinds of approximately $760 million. Sales were up 12% organically with industrial and communications of double-digits and transportation of high single-digits demonstrating the strategic positioning of our portfolio. Adjusted earnings per share was a record at $7.33, which was up 13% year-over-year and adjusted operating margins were 18.2% with expansion in the industrial and communication segments versus the prior year. For the full year, we returned $2.1 billion to shareholders between share buybacks and dividends, as our focus was on organic investment in the business, as well as return of capital to our owners. To conclude our financial overview for 2022, I want to discuss our guidance for the first quarter. It's important to establish a proper baseline for this guidance. In comparing year-over-year, we are looking at $3.8 billion in sales from the first quarter of fiscal 2022, and for sequential comparison, the 13-week sales from the fourth quarter were $4 billion. For the first quarter of 2023, we anticipate sales of around $3.75 billion, which is a 9% organic increase but a slight decrease on a reported basis year-over-year, influenced by approximately $400 million in foreign exchange headwinds. We expect adjusted earnings per share to be about $1.50, reflecting year-over-year headwinds of roughly $0.25 due to currency fluctuations, and an increased tax rate of 21%, up from the previous year. Looking at the guidance sequentially against the $4 billion from the previous quarter, we are forecasting a drop of $300 million in sales and $0.25 in earnings per share. About half of this decline in revenues is attributed to foreign currency impacts, with the rest divided between typical seasonal effects and reduced communications volume due to market moderation. The earnings per share decrease is driven by the mentioned foreign exchange and volume reductions, along with temporary effects from our proactive inventory cuts in the fourth quarter. Although we face some short-term, non-structural challenges, we are making progress in areas we can control, such as implementing price increases over the past year to help mitigate rising inflationary pressures. As previously noted, there is a lag in transportation between inflation and our ability to adjust pricing accordingly. We have initiated two more price increases, which should help elevate transportation margins back to the high teens by the second half of 2023. Despite the current challenges, we continue to benefit from favorable trends in our markets, along with strong performance from content growth. Our strong position in electric vehicles, smart factory automation, renewable energy, and high-speed cloud and artificial intelligence applications is advantageous. We remain dedicated to our business model and long-term value generation through growth, margin improvement, and robust cash flow generation. So, with that, wrapping up the highlight slide, let's turn to slide four and I'll share some more details on orders. For the fourth quarter, orders were $4.3 billion and this reflects resiliency in both transportation and industrial and also demonstrates moderation in our communication segment. Our backlog of $6 billion is up 11% year-over-year and I want to emphasize that we're seeing very little impact from push-outs or cancellation from our customers. In transportation, we had a book-to-bill of 1.03, along with a strong backlog position. This reflects favorable demand patterns. End demand for autos continues to be higher than what OEMs can currently produce, providing a favorable backdrop for production increases as our customer supply chain bottlenecks begin to resolve and dealer inventories get back to historical levels. Our content growth remains strong with content per vehicle expanding in fiscal 2022 to over $80 per vehicle from the $60 range of pre-COVID. We do expect further content expansion due to our global leadership position and increased adoption of electric vehicles globally. In our industrial segment, we had a book-to-bill of 1.01. Year-over-year order growth was driven by both Aerospace & Medical and our medical businesses, as these businesses continue to recover from pre-pandemic levels. And in our communications segment, orders declined year-over-year and sequentially reflecting expected decline in appliances and moderation in data and devices as the data center supply chain adjusts inventory levels for its cloud customers. Despite this market cyclicality, we expect to continue to outgrow the market in the data and devices business due to share gains and benefits from high-speed and AI implementations in the data center and cloud. Now, let me provide a little color on what we're seeing in orders geographically. On a 13-week organic basis by region, we saw year-over-year growth of 6% in China and Europe, while North America was essentially flat. On a sequential basis, we saw orders growth of 18% in China, with single-digit declines in Europe as well as in North America. So, with that as a backdrop of orders and backlog, let me turn it over to Heath and he'll get into segment highlights, as well as some information on the financials.

Thank you, Terrence, and good morning everyone. I will now briefly discuss year-over-year second results in the quarter on slides five through seven. You can see the details on the slides and I will talk about organic sales performance on a 13-week basis. Slide five, transportation sales were up 13% organically year-over-year, our auto business grew 16% organically with growth across all regions. We continue to increase our content per vehicle through our global leadership in EV. Electric vehicles now account for nearly 20% of auto production with further increases in production expected in 2023. To provide context, EV and HEV production has grown 3x from 2019 with 14 million units produced in 2022. Importantly, for 2023, we expect our market outperformance to be well above our stated 4% to 6% range in automotive. In commercial transportation, we saw 13% organic growth, driven by North America and Europe with significant market outperformance in all regions driven by content growth and share gains this year. In sensors, we declined 3% organically with our focus growth areas offset by continued portfolio optimization activities. At the transportation segment level, adjusted operating margins were 16.6% and the margins reflect the short-term impact of our planned inventory reduction along with the timing of price actions to offset inflationary pressures which Terrence mentioned earlier. Moving to the next slide, the industrial segment, sales increased 16% organically year-over-year. Industrial equipment was up 20% organically with double-digit growth in all regions and continued benefits from factory automation applications. Aerospace and defense was also up 20% organically with growth driven primarily by ongoing market improvement and commercial air. In energy, we saw 16% organic growth driven by increased penetration and renewable applications. Our medical sales were up 3% organically with increases in interventional procedures as the medical device market continues to work through supply chain challenges. Adjusted operating margins for the segment expanded year-over-year to 16.5%, driven by higher volume, price actions, and implementation of previous cost actions. The next slide communications. We had 3% organic growth year-over-year. In data and devices, we saw continued market outperformance driven by content growth and high speed cloud and share gains in artificial intelligence applications. Our appliances business declined 46% organically, reflecting the expected moderation in this end market that will continue into fiscal 2023. Communications adjusted operating margins were 21.7%, reflecting the lower sales in the appliance business. If you turn to slide eight, where I'll provide more details on the Q4 financials. As mentioned earlier, Q4 includes an extra week and we had provided tables in the appendix that bridge sales, margins, and EPS for that extra week. Sales of $4.4 billion were up 14% on a reported basis year-over-year and currency exchange rates negatively impacted sales by $348 million versus the prior year. Adjusted operating income was $757 million, with an adjusted operating margin of 17.4%. We are being impacted in the near-term by non-structural pressures of foreign exchange, inflation, and the previously mentioned inventory reduction. While we can't influence currency exchange rates, we are continuing to be proactive on recovering inflationary pressures through price increases. Additional upcoming price increases will go into effect in transportation helping to lift segment margins back to the high teens in the second half of fiscal 2023. And while our Q4 inventory reduction has a near-term impact on margins, we do expect margin expansion as we move through this year with the back half closer to run rate company margins and as you know, we were in the 18% range for most of fiscal 2022. GAAP operating income was $660 million and included $82 million of restructuring and other charges and $15 million of acquisition-related charges. For the full year, restructuring charges were approximately $150 million, which were in line with expectations. We did ramp up our restructuring charges in Q4 to proactively react to the market environment. While I expect restructuring charges in fiscal 2023 to be roughly consistent with fiscal 2022, the charges will be more heavily weighted into the first half of the fiscal year and we will continue to further evaluate cost actions as we move forward. Adjusted EPS was $1.88 and GAAP EPS was $2.21 for the quarter, and included a tax-related benefit of $0.57 related to discreet tax benefits during the quarter. Additionally, we had restructuring, acquisition, and other charges of $0.25. The adjusted effective tax rate was approximately 19% in both Q4 and fiscal 2022 and for Q1 and fiscal 2023, we expect our adjusted effective tax rate to be roughly 21%. Importantly, we continue to expect our cash tax rate to stay well below our stated ETR for the full year. Turning into year-over-year comparisons on slide nine, fiscal 2022 sales of $16.3 billion were a record at up 9% on a reported basis and 12% organically year-over-year. Currency exchange rates negatively impacted sales by approximately $760 million versus the prior year. Due to the further strengthening of the U.S. dollar against other currencies, we expect currency exchange rate headwinds to be approximately $1 billion for fiscal 2023 with roughly 70% of this headwind to be felt in the first half of the fiscal year. This equates to approximately 600 basis points of headwinds to reported growth in fiscal 2023. Adjusted EPS expanded 13% year-over-year to $7.33 and adjusted operating margins were 18.2% with year-over-year expansion in our industrial and communications segments. Turning into cash flow, free cash flow for the year was approximately $1.8 billion, with over $2 billion returned to shareholders through share buybacks and dividends. We continue to remain disciplined in our use of capital and our long-term strategy remains consistent, which is to return approximately two-thirds of our free cash flow to shareholders and use one third for acquisitions. Near-term we have been aggressive in buying back our stock and taking advantage of investing in our own organic value creation opportunities. And before we get into questions, let me wrap up. We delivered strong performance this past year. Our teams have continued to execute well in this volatile environment to effectively serve our customers. And while we have some near-term headwinds, I am excited about the opportunities we have ahead of us this fiscal year. Our positioning of the portfolio will drive content and performance. We also have a trajectory for further margin expansion and EPS growth through actions we can control, including price increases to fully offset inflation, cost reduction initiatives, and a strong balance sheet that can support investments for growth while continuing to return capital to shareholders. So there's a lot to be excited about there. Now, let's open it up for questions.

Angela, can you please give the directions for the Q&A session?

Hi, good morning team. And thanks for taking my question. Number of moving parts in the quarter, the extra week and inventory reduction shifting in demand. So, I was just hoping to dig into maybe the earnings trajectory into 2023. So, could you walk us through or give us a sense of exit rate 2022 sales and margin levels?

Sure, David. This is Heath, I'll take it. We just shared several factors that might be complex, and I appreciate the chance to clarify anything that seems unclear. As we finished the year, we experienced good order volume, which was evident in our sales figures. We did benefit from some of that flow-through, but we are still facing several pressures. We chose to reduce our inventory this quarter, decreasing it by over 10%, which amounts to $350 million. This naturally affects our margins as well. On a positive note, we have aligned our inventory days more closely with a healthy balance that corresponds to our sales volume, which is encouraging. This approach also positively influenced our cash flow, which reached a record nearly $750 million this quarter. We will continue to monitor this closely as we progress. However, there will be a short-term negative impact on our profit and loss statement. We're also encountering considerable price pressures, especially in transportation due to inflation and rising oil-based costs for resins. We have planned increases already agreed upon that will take effect around January and into the second quarter, which should provide a nice benefit as we transition from the first half to the second half of the year. Meanwhile, our communications segment is adjusting as we anticipated. We predicted that appliance sales would moderate, and we have begun to see this reflected in both our orders and sales, which is slightly diluting the segment margins in communications. On another note, we are observing heightened foreign exchange impacts due to the strengthening dollar. As I mentioned back in July, we initially estimated our FY 2023 exposure at about $300 million, but we're now projecting it at $1 billion, with approximately $700 million affecting us in the first half of the year. While this won’t impact our margins significantly, it will affect our earnings per share, and we are certainly experiencing that in the first quarter. We acknowledge that we cannot control this but remain transparent with analysts and shareholders about the situation. There are several variables to manage as we navigate through the year. At the same time, we are proactive. We talked about ongoing restructuring efforts aimed at adjusting for an expected softer macroeconomic environment. I appreciate your question, and please let us know if you have any follow-up inquiries.

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

Yes, thank you. Good morning. I was wondering if you can talk a little more about the order and backlog trends and comps, if you could share some color on that? And maybe the magnitude of the inventory adjustment, potentially the GRC being at these ODM suppliers to hyperscalers. And if I could, I was also wondering if you could comment on how TE's performance was an outgrowth versus production in fiscal 2022 for transport and how much of that was inventory adjustments in 2022 as well? Thank you so much.

Sure, I'll address that and good morning. I want to discuss orders a bit. While I know you mentioned comparisons, I'll first talk about our observations in orders and then address content outperformance. To be frank, having a book-to-bill ratio below one, given our recent bookings and backlog build, isn't surprising to us. As global supply chains improve, we continue to anticipate our book-to-bill will dip below one. It's important to note that as supply chains improve, including ours, we expect our customers to reduce their backlogs with us. I want to clarify that this does not indicate a decline in demand across our markets; we're simply not seeing that. As I mentioned earlier, cancellations or delays are not significant. When looking at segments like TS and IS, the book-to-bill ratios are normalizing, demonstrating resilience. In the communications segment, we've seen capital expenditure growth among our cloud customers of 20% to 30%, and we have outperformed expectations, which is reflected in our growth rates. However, as cloud capital expenditure returns to more typical levels, the ODM supply chain is experiencing excess inventory that is being addressed, which could affect us for a couple of quarters, particularly evident in our data and devices business. Additionally, the appliance market, which benefited during COVID, is moderating as anticipated, influencing our order patterns. Now, regarding your second question about content outperformance, it's crucial to note, as Sujal and I previously mentioned, our revenue has been less affected by supply chain disruptions, now only about $50 million that we haven't built, down from about $100 million. Content outperformance is at the high end of our forecast range of 4% to 6%. Looking at the auto supply chain, we are optimistic that growth is at the high end of the range for 2022, and we expect it to exceed the high end for 2023. We don't anticipate significant inventory issues in the auto supply chain based on our observations. While we’ve noted a moderation in orders, customers are becoming more comfortable with working through their backlogs.

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

Hi, good morning. I was just wondering since you're not providing a full fiscal year guidance for the new fiscal year, if you could maybe walk through what you're thinking about your end markets at this point in time? Thank you.

Yes, thank you, Steve. For the first quarter, we are observing some volatility in the macro environment, which is not surprising. The insights I'm sharing reflect our current observations and business planning, though changes could occur depending on global macro developments. Let’s break it down by segment. Starting with transportation, it has faced challenges over the past couple of years. Auto production has remained around 76 million to 77 million units due to supply constraints, the war in Europe, and extended COVID-related lockdowns in China. While it's encouraging to hear some customers report improvements in semiconductor supply, the key factor will be their ability to increase production to meet the demand that exceeds their current output. Thus, we still see the end demand for autos being higher than the current production levels, which sets a promising stage for next year. We also anticipate outperforming the market, achieving growth above 4% to 6% this year, driven by our strong global leadership position in electric vehicles. The penetration of electric vehicles is expected to continue rising as a proportion of total production. In the commercial transportation sector, we're looking at a market that has declined by double digits this year, largely due to issues in China and emissions standards. However, we expect an improved market situation in China moving forward. Throughout the year, we've experienced outperformance in commercial transportation across all three regions, even in a challenging market. Turning to industrial, we see a robust setup. In terms of orders, both backlog and new orders are looking strong. We expect the commercial air and medical fields to continue their recovery, with further growth anticipated in 2023. In the commercial air sector, single-aisle aircraft production has returned to pre-pandemic levels, while double-aisle production is still at about 50%. Some aircraft manufacturers are indicating plans to increase production and address the growing demand for double-aisle aircraft. Additionally, our energy division, particularly in wind and solar, has shown strong double-digit growth this year, with renewable energy making up 20% of our sales, and we expect that growth to continue. The industrial equipment market has been very strong for us in the past two years. While we see promising trends, we will face challenging comparisons moving forward as we focus on higher growth applications in robotics and new programs related to Ethernet connectivity, which will help us exceed market performance even as we navigate tough comps. In communications, we are seeing a weakening appliance market as anticipated, reflected in the sales decline during the fourth quarter. We expect this trend to persist into the coming year. Regarding data devices, we foresee a decline in cloud capital expenditures from previous levels. The ODM supply chain adjustments in response to hyperscale demand will also impact us in the early part of this year. Therefore, it's reasonable to predict that our data and devices business will face a downturn this year due to these factors. I realize I provided a lot of information in response to your straightforward question, but this is how we are analyzing the macro conditions as we go into 2023.

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

Good morning. I would like to revisit the gross margin, particularly concerning the effect of the $350 million inventory reduction. In Q4, it seems your gross margin decreased by 220 basis points year-over-year, and you are projecting a decrease of about 200 basis points for Q1. How much of this decline is tied to the inventory reduction? Is this expected to be a one-quarter concern, or will it extend into Q2 of 2023? Thank you.

Hey Matt, it's Terrence. I'll take that. I want to be clear that this was the inventory we took out. I know I talked a lot about the D&D supply chain with our cloud customers, but this is indeed our inventory. As Heath mentioned, our inventories are back in days on hand in the mid-80s; previously, it was running in the 90s while we managed the supply chain. We made a proactive decision to reduce inventory. With factories incurring fixed costs and fewer units being processed, higher costs needed to be addressed. We experienced a partial impact in our fourth quarter, and a more significant impact will be seen in the first quarter, approximately 100 basis points. There will be a slight impact in the second quarter as well, but it will be temporary. Regarding our reasoning, we made deliberate choices to hold more inventory throughout the year. However, as our supply chain improved and we observed a more normal flow, we determined it was essential to align our inventory levels. We're committed to consistently serving our customers, and we believed this was a prudent move for cash generation, especially given the macroeconomic uncertainty. The only notable supply chain challenges we face involve some niche materials and markets still recovering to pre-pandemic levels, such as medical and commercial aerospace, which isn't surprising. Our goal was to realign inventory, and this does come with a gross margin impact, which we will see early in 2023, but this was a proactive measure on our part.

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

Thanks a lot. Terrence, I think there's going to be a lot of focus on operating margin trajectory in fiscal 2023 beyond the mid-16% I think we're going to do in December. I was wondering if you could provide some clarity on how do you think margins stack up in 2023 qualitatively across segments? And really specifically on transport, reviewing the back half, recovery looks better versus the first half. And then CIS, do you think we end up dipping below 20 over there? Just any breakdown on margin trajectory going forward would be really helpful? Thank you.

Thanks, Amit. This is Heath. I appreciate the question. No, listen, I think it's certainly on point. As we think about transportation margins and some of the things we've already discussed this morning, a couple of things that are pressuring transportation margins. One is we talked about the price-cost differential and what we're looking forward to in terms of seeing higher prices go into effect that we've already got agreement on later in the first half of our fiscal year that will have a benefit as we move into the second half on transportation margins. The other thing that, Terrence just walked Matt through was on the inventory side. As you can imagine, we did take out $350 million of inventory as we burn through the accounting element of that and the pressure it puts on margins, there is a disproportionate amount of that that hits transportation. So again, as we just talked about, that will have a benefit as we think about our second half versus our first half. So, transportation margin is definitely a second half improvement based on a couple of things we talked about. Industrial is honestly performing very well. And we've been pretty vocal and transparent with you about our journey on transportation and the restructuring journey in terms of rooftop consolidations that we've taken on. The business has done that well and has absorbed some acquisitions in the middle of this journey that are going to be very good returns for the company and for the shareholders. So, we're looking forward to those. At any given time, there might be a quarter pressure here or there, but we are making strong progress towards our journey towards high-teens margins even while absorbing some of the dilutive impact on acquisitions. So stay tuned on industrial, but we feel good about our trajectory there in 2023. And then the last part of your question, Amit, was around transfer and communications margins and being able to stay north of 20%. Listen, we've never advertised it as a high 20% business. We've enjoyed a couple of years, and we basically have said as a reminder that at those volume levels, it just shows what kind of margins that we can generate at those volumes. Now that we're seeing volumes come back down, Terrence mentioned earlier on a question that we do expect communications to be down modestly year-over-year on the top line, we would expect that the margins would moderate. I still think they'll be a little above 20% for the full year, but there's some pieces there that in any given quarter that might dip below. But generally, I feel like we'll be above 20% for the year there, which still shows the resiliency of that even at lower volumes.

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

Thank you. So I wanted to talk about more the margin outlook for Transport Solutions, but maybe more so focusing on price cost. Prior commentary from the company has said that you're recovering about two-thirds of cost inflation and it translates to more than $200 million loss at the EBIT line based on my math. Presumably, the high majority of all of that is transport. So I guess, as we look into the back half of next year, and we see pricing going higher in cost maybe flat to down, at least with metal, how should we think about that 200-plus kind of EBIT loss? Could that get to neutral? Is there any scope for that getting beyond neutral? Any color there would be helpful. Thank you.

Thanks, Chris. I'll handle that. First, I believe your calculations are quite accurate, so I commend you for that as it's not an easy task. Our inflationary pressures stem from four main sources: metals, resins used in our molds, freight costs, and a overall increase in utility costs, particularly in Europe for running our factories. We've started to see some moderation in these areas as capacity comes back online. However, we're still experiencing inflationary pressure from resins and utility costs driven by energy prices. We expect this trend to continue even as some areas may begin to moderate and potentially decrease year-over-year in terms of additional pressure. As you noted, we have recovered about two-thirds of that inflationary pressure through pricing on a total enterprise basis, which still leaves us with a gap of a couple hundred million dollars. When we analyze it by segments, the situation varies. While the overall company recovery is two-thirds, we've seen greater recovery in FY 2022 in the industrial and communications sectors. The key difference is that in these segments, we work more with our distribution channel partners, making it easier to pass on price increases efficiently and in a timely manner without needing to reopen contractual negotiations. This has allowed those segments to recover pricing more effectively. Transportation, however, poses a challenge due to more direct OEM contracts which are often tied to platforms. Often, when trying to recover inflation in this space, the discussions around pricing adjustments can take six to nine months to materialize. That's the current situation we're facing in transportation. Fortunately, we anticipate those price increases will come into effect later in the second half of this fiscal year, and I believe that, as we implement these changes, we will see an improvement in the two-thirds coverage of pricing. Looking ahead to the latter half of the year, I encourage you to stay tuned for developments as that ratio is expected to improve as we transition from the first half to the second half, giving us more confidence in our plans for the remainder of the fiscal year.

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

Thanks so much. Heath, you mentioned some higher restructuring. I was wondering if you could give a little bit more details on that stepped-up level in the fourth quarter. It looks like it was really in the transportation business. And I think on your guidance, it looks like restructuring is still going to be a healthier level in the first quarter. So maybe just a little bit more on those actions, what you're looking for in terms of a payback. And when can restructuring return to more normalized levels?

Thank you for the question. As we mentioned earlier, we incurred over $80 million of the $150 million in charges for fiscal year 2022 in the fourth quarter, with much of it related to transportation. We have been progressing through our restructuring programs, focusing on consolidating our factory footprint. Specifically, we have been reducing our European presence, primarily in transportation and to a lesser extent in our Industrial segment. These efforts are either completed, on schedule, or in progress since the charges were taken, and the expected payback remains consistent with our guidelines, typically within a two to three-year timeframe for European consolidations. The fourth quarter charges and those anticipated for the first quarter reflect a more cautious outlook on the macroeconomic environment, prompting us to take proactive measures. However, we will not reduce capacity to a point that would hinder our ability to respond to market rebounds, and these adjustments will not be uniformly applied across our entire business but will disproportionately affect our Transportation segment, including automotive and a few other targeted areas. This initiative will focus on cost reductions, aiming to lower our overall cost structure, especially our fixed costs, to maintain flexibility regarding margins as we proceed.

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

Yes. Good morning. Thank you very much for taking the question. I want to understand what's making the company take the view that 2023 content growth will be higher than the 4% to 6% target? And do you think there will be any inventory reductions that your customers could be making and that perhaps could offset some of the underlying content growth this coming year? Thank you.

Thank you for your question, Mark. When we analyze the increase in electric vehicle adoption, it's clear that this trend is significantly contributing to our content growth. We anticipate that our growth will exceed the upper end of our 4% to 6% range. This outlook considers that production levels remain stable, without major supply chain disruptions influencing our expectations. As we observe our orders and the book-to-bill ratios in the automotive sector returning to more traditional figures, we feel confident. While a significant change in production could potentially affect the supply chain, we do not foresee any major issues at this time.

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

Hi. This is Sumeet on for Samik Chatterjee. Thanks for taking my question. I just wanted to ask on transportation relative to the underlying market, like what are your expectations for auto production growth for 2023? Like IHS is currently forecasting a 4% growth, like amounting to nearly 85 million vehicles produced. What's your take on that? Thanks.

Thank you for the question. And I think what's important and I know at times, we don't include light vehicles, so it might be a little bit different on how we talk about numbers and how you talk. We saw about 20 million units made in the fourth quarter of 2022. And we also expect 20 million units to be made in the first quarter and there will be seasonality in it. And we think production can be a little up. But net-net, we don't see it's going to be a rocket ship of production increases. We sort of view it will be up low single-digits, which I don't think is far off of what you say. So net-net, I think that's how we see production right now as the OEMs try to make sure they fulfill the demand that's in excess of production.

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

Thank you. Heath and Terrence, at this time of year, you typically give a little bit more on the 2023 or the next year outlook. I know I think I heard Terrence talk a little bit about the end markets. But then with the moving parts of inventory digestion, book-to-bill and all that, I was thinking on the company totality level, any preliminary thoughts on either sales or margins or cost structure or cash flow for kind of the full years as we look out because there are a lot of moving parts?

Hey, Jim, this is Heath. We need to be cautious about our statements since we haven't provided guidance for the full year 2023, apart from a few aspects like the current state of foreign currency and our expectations for restructuring. Those figures are for the entire year. As we've discussed today, we compared the first half of the year to the second half. We expect margins to improve, and that should reflect positively across our profit and loss statements. From a cash flow standpoint, we finished the quarter strongly with record free cash flow, primarily due to our inventory reduction. We anticipate a robust cash year in 2023 and plan to finance all the organic opportunities available to us, as we operate in various markets where we can exceed market growth. This should reassure you about our confidence in revenue. Overall, I feel optimistic about our cash opportunities—not just in terms of returning funds to shareholders, but also for capital expenditures and necessary investments, while still delivering a solid cash flow year compared to 2022. I realize this may be more general than you'd prefer, but that's about all I can share at this moment.

All right. Thank you, Jim. Can we have the next question, please?

Hey, thanks. I was just maybe on automotive. You talked about content outgrowth this year. It sounds like it was around six points. And I'm just curious what that would be if you stripped out some of the price recoveries just to kind of get a sense of the underlying content growth? And then I think as we look ahead, how are you thinking about the ability to sustain that six points of growth over market or potentially even do better than that? And as you look at your position amongst some of the big OEMs that are poised to be the largest players in EV, what gives you confidence that you're seeing content expansion, especially with those OEMs?

Certainly. I would like to clarify a few points, and I apologize for not including them in my previous response. As we approach a revenue growth of over 6% this year, it's not just due to content but also to the cost benefits we have discussed. I neglected to mention that for 2023. Looking at our achievements so far, our electric vehicle revenue in the Automotive and Transportation segment stands at $1 billion. This current revenue reflects our existing position. The momentum we have is driven by platform wins, which help us build capacity, and we are aware of those wins. The key uncertainty lies in which cars will be produced and the preferences of consumers. Considering the programs we’ve secured, we are confident about our positive content momentum and our global positioning. This includes not only the original equipment manufacturers (OEMs) in the US but also significant markets like China, which produces about a third of the world’s electric vehicles. Of the 14 million vehicles that Heath mentioned, 4 million to 5 million are made in China, making that a crucial market for us along with our European, Japanese, and Korean customers. We are optimistic about our content and our strong global position, evidenced by the $1 billion in revenue generated in 2022, highlighting our deep penetration in the EV sector.

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

Great. Thanks for taking the question. Terrence, regarding the outlook for communications normalization, clearly, there's been a lot of data center capacity put into places since COVID hit in 2020, and that's, of course, benefited data in devices. What I'm wondering is, as you look forward, do you think there are opportunities to go back and strengthen the system after what at times has seen like a very frantic piece of investment in the past three years? Any near-term changes in channel inventory side, of course? Thanks.

Yes. So, hey, Luke, one of the things is, I think, there were elements that were certainly around COVID from an investment. But I also think it really supports their core business models. It could be around gaming elements and so forth where people want to have service, it's not just about COVID, but it's also about how the network that we've all used has had to get strengthened, and I also think there's a big element about refresh that you're always going to have around the energy efficiency of the cloud infrastructure and the data centers that go into it. So, when we look out, there will always be steps around how the technology improves to make them more efficient. Certainly, the speeds in the data center are always very important, and some of that will come in as chipsets come out for the data center. You will continue to see a refresh element of the cycle. I'm not sure you're going to have the 20%, 30% growth we've had from the past couple of years. So, when we talk about it, we really view it's a moderation off of two very strong CapEx years by the cloud customers. But I think when you think about efficiency, AI, how they continue to improve the compute, the move in the store element of everything that a data center and a cloud needs to do that all plays into content growth for us. So, we're very excited about that trend long term. Certainly, we think as we're starting 2023, we have a little bit of moderation on the CapEx side, as well as the supply chain getting in line, like you said, from a channel perspective.

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

Hey, guys. Good morning. This is Tristan in for Joe. Just wanted to double click on your industrial orders, which I believe was down sequentially despite that extra week? Like any reason for that, anything you can highlight?

No. As I said on the call a little bit, in industrial equipment, we have seen a moderation a little bit but off a very high level. And I wouldn't use the word moderation, like we've been talking about in communications. Our Industrial Equipment business has had very strong growth. It does look like the orders are moving a little bit sideways, and actually coming down, and that's what you're really reflecting in our orders. And also realized orders do also represent, they do have currency effects in them as well. So you'll also see that sequentially have an impact to what Heath and I talked about from a sales element also does affect our orders.

Okay. Thank you, Tristan. And I'd like to thank everybody for joining us on the call this morning. If you have any more questions, please contact Investor Relations at TE. Thank you and have a nice morning.