Earnings Call Transcript - TEL Q4 2021

Operator, Operator

Ladies and gentlemen, thank you for standing by, and welcome to the TE Connectivity Fourth Quarter and Final Fiscal 2021 Earnings Call. At this time, all lines are in a listen-only mode. Later, we will conduct a question-and-answer session. As a reminder, today's call is being recorded. I would now like to turn the conference over to our host, Vice President of Investor Relations, Sujal Shah. Please go ahead.

Sujal Shah, Vice President of Investor Relations

Good morning. And thank you for joining our conference call to discuss TE Connectivity's fourth quarter and full-year 2021 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. 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.

Terrence Curtin, CEO

Thank you, Sujal, and I also appreciate everyone joining us. I'm going to talk about our results for the fourth quarter as well as fiscal 2021, as well as the outlook for the fiscal 2022 first quarter. So, before Heath and I get into the slides, let me frame out the performance relative to the broader market environment that we're operating. I am pleased with our results in the fourth quarter, as well as the strong performance that we delivered for the full year. We continue to experience global GDP growth, with strong end market demand across most end markets that we're strategically positioned to focus on. This broad growth that we're seeing is both in the consumer and capital spending areas. On the consumer side, demand for autos and life sciences remains strong, and we continue to see increases in medical procedures that benefit medical device sales. On the capital spending side, we see increased investments that relate to cloud and datacenters, factory automation, semiconductor capacity, as well as the need for more renewable energy sources. When you look at the results we're going to talk about today, you're going to see this broad strength reflected in our orders and our backlog that will benefit us as we go into 2022, as well as our results in 2021. While certainly this demand environment is a positive, the reality is we're still in a world that's dealing with COVID, and global supply chains that have not been able to keep up with these strong demand trends. Within this backdrop, we are continuing to capitalize on growth opportunities across our served markets. In the fourth quarter, we delivered 16% organic growth despite auto production declines caused by our auto customer supply chain. This performance demonstrates the strength as well as the diversity of our portfolio. We have strategically positioned TE around certain secular trends, and you're seeing the market outperformance in each of our segments as a result of this positioning. In Transportation, our leadership position is enabling us to deliver content growth from both electrification of the car, as well as increased adoption of electric vehicles globally. In Industrial, we're benefiting from accelerated global capital spending around factories. In Communications, we're driving content and share gain in cloud applications. In addition to the strong top line growth outperformance versus our markets this year, we have executed well to deliver market expansion in each of our three segments. The last proof point that I think is important and shows the strength of the portfolio is how our full-year results compare to pre-pandemic levels of 2019. Both our sales and adjusted earnings per share in fiscal '21 were up double digits versus 2019, and we expanded adjusted operating margins by over 100 basis points by continuing the margin journey that we're on. More importantly, we also remain excited about the additional growth and margin opportunities that we still have ahead of us. Now with that as a backdrop, let me get into the slides, and I'll discuss the highlights that we have listed on slide three. Our teams had strong execution results in the fourth quarter despite reductions in auto production and ongoing challenges in the broader global supply chain. We generated sales of $3.8 billion, with 16% organic growth, and adjusted earnings per share ahead of guidance, at $1.69, which was up 46% year-over-year. Adjusted operating margins were 18.5% as a result of the increases across all three segments. When you look at the full year, year-over-year sales were up 23%, adjusted operating margins expanded approximately 400 basis points, and adjusted earnings per share was up over 50%, to $6.51. Also as important as earnings is where we generated in free cash flow. Our free cash flow was about $2 billion, with approximately 100% conversion to adjusted net income for the year, demonstrating our strong cash generation model. We also continue to remain balanced in our capital deployment, with about three-quarters of our free cash flow returned to owners this past year, and the remainder used for M&A, including the ERNI acquisition in the Industrial segment, that we mentioned last quarter. When you look at our orders in the fourth quarter, they remain strong at $4.1 billion, with strength in each segment, and our book-to-bill was at 1.08. With these orders and where we position TE, we do expect the strong performance of our portfolio to continue into the first quarter, with approximately $3.7 billion in sales, which will be up mid-single digits organically year-over-year despite a roughly 20% expected decline in year-over-year auto production. We expect strong double-digit growth in both our Industrial and Communications segments, and I think this is another point that reinforces the diversity of the markets that we serve. Adjusted earnings per share is expected to be approximately $1.60 in the first quarter, and this will be up 9% year-over-year. Now, let me talk about the markets and frame it to where we were just 90 days ago, when we last spoke. In Transportation, consumer demand for autos remained robust, but clearly ongoing challenges with semiconductors and the broader supply chain continue to impact our auto OEM customers' ability to produce. Global auto production came in lower than we expected just 90 days ago, as our customers reduced production to enable the supply chain to catch up. Auto production was approximately two million units lower than we anticipated in the fourth quarter. And we're expecting auto production to be in the 18 million unit range in our first quarter. This first quarter production will be well below the nearly 23 million units made in the first quarter of 2021. The key for us is that the trends around content growth for TE remains strong, and we expect content growth to be at the high end of the four to six-point range in fiscal '22, as we continue to benefit from increased electrification and higher production of electric vehicles. Now versus 90 days ago in our Industrial segment, the key is that we continue to see an improving backdrop which is benefiting our industrial equipment and energy businesses. And our medical business is growing year-over-year as interventional procedures increase. The one area that we've not seen improve is the commercial aerospace business, which is sort of staying stable, and we've not seen an inflection point in that business yet to higher or lower growth. In Communications, versus 90 days ago, we continue to see favorable end market trends with global growth in cloud capital expenditures and strength in residential demand benefiting our appliances business. Now, while that's a view of what we've seen versus 90 days ago from a market perspective, I also believe in this environment it's important to tell you what we're seeing in our supply chain. While challenges remain in the broader supply chain, we have seen some improvement in our availability of certain raw materials in our own supply chain versus 90 days ago. 90 days ago, we thought we were impacted by about $100 million of revenue due to us not having availability of supply; this quarter end, that's down to about $50 million. With this improvement, this will enable us to increase production and inventory levels accordingly, to ensure we can meet demand as our customers resolve their supply issues. Now, before I move into orders, that'll start on slide four, I do want to take a moment to mention a few key highlights on the progress we made this year on our ESG initiatives. Earlier this year, we issued our 11th Corporate Responsibility Report, which discusses our One Connected World strategy which encapsulates our ESG strategy. We hope that you've read this report which highlights the efforts that drive and are internally related to our impact on the planet, as well as the innovation our engineers bring to our customers to ensure we're enabling sustainable applications. Some of the key highlights I want to mention is that on the environmental side we set up a new goal to decrease Scope 1 and Scope 2 greenhouse gas emissions by over 40% on an absolute basis by 2030. This new goal is above and beyond the 35% reduction we've already made in absolute greenhouse gas emissions over the past decade. We also continue to make progress in sourcing renewable electricity. Today I'm happy to say over 20% of TE's production currently uses carbon-free electricity. This past year, we began to report Scope 3 emissions back in July. If you look at social initiatives, we set a goal to increase the number of women in leadership positions by over 26% by 2025. I'm happy to say we continue to focus on employee safety and engagement throughout the pandemic. We received good feedback from our employees on how we've been there for them during this difficult time. So, clearly, I'm pleased with the continued progress that we're making towards what our purpose as a company is, which is to create a safer, sustainable, productive, and connected future. So, now let me please get into the orders on slide four, and we'll go through it by the segments on both of them and also on a geographic basis. For the fourth quarter, our orders were over $4 billion with year-over-year order growth in all regions. Our order trends and backlog remained strong in each segment and the order patterns we're seeing are as we expected. As we've been mentioning throughout the year and as you've seen in our book-to-bill ratios, order levels have been elevated with customers placing orders for delivery beyond the current quarter due to the broader supply chain situation. As a result, we're coming into fiscal 2022 with a strong backlog position that is higher than we typically see for our business. When we look at the order patterns at a segment level, industrial and communication orders are trending as expected with continued momentum in areas like factory automation and cloud applications. I also want to highlight and remind you that in the industrial and communications segment, we have a relatively large portion of our business that goes through our channel partners. We're seeing our booking patterns begin to align more closely to our settlement, which is a good sign. One key thing to highlight around our channel partners is that in 2021, we did not see inventory levels increase with them, even though they had significantly higher level business with much higher inventory turns this year. Looking at transportation, we are seeing order levels match the production dynamics that are aligned with our guidance. When you look beyond the near-term noise of auto supply chain pressure, it's important to remember that consumer demand for autos remained strong and dealer inventories remain extremely low. We believe this is a very favorable setup for medium and longer-term auto production growth. Now let me add some color on what we're seeing organically from a geographic perspective on a year-over-year basis. We continue to see growth in Asia where China orders were up 17% and growth across all three segments. In Europe, orders were up 21% and North America orders were up 26%. On a sequential basis, we saw orders decline in each region that reflect the order patterns I just talked about in our segments. But one key difference is we did see growth in our transportation segment orders in China sequentially where our auto orders were up 9%. So, with that order backdrop, let's get into the segment year-over-year results and they will be on your slides five through seven. Starting with transportation, segment sales were up 16% organically year-over-year with growth in each of our businesses. Our auto business grew 12% organically despite the declines in auto production that I mentioned. We continue to benefit from increased production of electric vehicles as our technology and products are enabling high voltage architectures and applications with every leading customer on the planet. Hybrid and electric vehicle production grew 50% year-over-year, increasing from roughly 6 million units produced in 2020 to roughly 9 million units produced globally in 2021. We also continue to benefit from content growth to non-electric vehicles driven by ongoing safety, data connectivity, comfort, and autonomy features. As a result of these content drivers, our content per vehicle has accelerated over the past couple of years from the low 60s per vehicle to the mid-70s this year. We expect to continue to outperform auto production going forward as the content we've setup and the wins we have continues to grow. Turning to our commercial transportation business, we saw 38% organic growth with increases across all submarket verticals. We're continuing to benefit from stricter emission standards and the increased operator adoption of Euro 6, which reinforces our solid position in China. We're also pleased to announce that two leading heavy truck OEMs have awarded us high voltage connectivity wins on their new electric vehicle platforms that they're rolling out. This will provide future content growth and reinforce our market leadership position in the commercial transportation market. In our sensors business in the segment, we saw 15% organic growth driven by transportation applications with the new program ramps that we've talked to you about in the past few years. For this segment, adjusted operating margins expanded nearly 500 basis points to 18% driven by higher volume and strong operational performance by our team. Now, turning to the industrial segment, our sales increased 6% organically year-over-year. Industrial equipment was up 32% organically with double-digit growth in all regions driven by momentum and factory automation applications, where we continue to see the benefit from accelerating capital expenditures in areas like semiconductor manufacturing and in the automotive space. Our AD&M business declined 18% organically year-over-year, driven by continued market weakness I talked about earlier. In our energy business, we saw 8% organic growth driven by increases in renewables, especially global solar applications. It was nice that our medical business grew 5% year-over-year and is growing in line with the recovery that we're seeing in the interventional procedures. At a margin level, the segment expanded margins year-over-year by 200 basis points to 15.9% driven by strong operational performance. Now, let me turn to communications. Our teams continue to demonstrate strong operational execution while capitalizing on the growth trends in the markets that we serve in this segment. Sales grew 36% organically year-over-year for the segment and in both businesses. In data and devices, performance continues to be driven by the position we built in high-speed solutions for cloud applications. We continue to see capital expenditures increasing by our cloud customers, and our content growth enables us to grow cloud-related sales at double the market rate this year. In our appliance business, we saw double-digit growth in all regions driven by both consumer demand and continued share gains. It's clear that our communications team continues to deliver outstanding performance with record adjusted operating margins of 24.7%, which was up 300 basis points versus a strong quarter in the prior year. Overall, our segment teams are capitalizing on the growth trends in their end markets, demonstrating the diversity of our portfolio while delivering strong operational execution in a challenging supply chain environment. You're seeing this reflected in our results both for our fourth quarter as well as our full year, and we expect this to continue into 2022. So, with that as a segment and market overview, let me turn it over to Heath, who'll get into more details on the financials as well as our expectations going forward.

Heath Mitts, CFO

Thank you, Terrence, and good morning everyone. Please turn to slide eight, where I will provide more details on the Q4 financials. Sales of $3.8 billion were up 17% on a reported basis and 16% on an organic basis year-over-year. Currency exchange rates positively impacted sales by $51 million versus the prior year. Adjusted operating income was $706 million with an adjusted operating margin of 18.5% with strong year-over-year fall-throughs. GAAP operating income was $660 million and included $38 million of restructuring and other charges and $8 million of acquisition-related charges. For the full year, restructuring charges were $208 million in line with expectations, and I expect restructuring charges to decline in fiscal '22 to approximately $150 million. Adjusted EPS was $1.69 and GAAP EPS was $2.40 for the quarter, and included a tax-related benefit of $0.92, primarily related to decreases in our valuation allowances associated with tax planning. We also had a charge of $0.07 related to the annuitization of the reapportioning of our U.S. pension liabilities. Additionally, we had restructuring, acquisition, and other charges of $0.14. Free cash flow was approximately $535 million for the quarter. During the quarter, we utilized approximately $300 million for acquisitions, including ERNI in our industrial segment, which Terrence mentioned earlier. The adjusted effective tax rate in Q4 was 20% and approximately 19% for the full year. For 2022, we expect an adjusted effective tax rate around 19%, but continue to expect our cash tax rate to be in the mid-teens. So, turning to slide nine, this slide puts some perspective on our performance this year and shows how we performed from fiscal '19 to '21. Over this time period, we had to overcome a challenge in operating environment and our performance is demonstrating the strength and diversity of our portfolio and the strong execution of our teams. We are back above 2019 pre-COVID levels on every financial metric, with sales up 11%, adjusted operating margins expanding over 100 basis points, adjusted earnings per share increasing by 17%, and free cash flow up 29%. I am pleased with how our teams performed to deliver the strong results through this cycle. To provide some segment level examples, our transportation sales are up approximately 15% versus fiscal '19, despite auto production declining over 11% during that same timeframe. Similarly, in our communication segment, sales are up approximately 25% over this time period, significantly outperforming our end markets. This also demonstrates some of the content benefits we are seeing across the portfolio. Turning to year-over-year comparisons, fiscal '21 sales of $14.9 billion were up 23% on a reported basis and 18% organically year-over-year. Currency exchange rates positively impacted sales by $444 million versus the prior year. We would expect currency exchange rates to be a year-over-year headwind in our first quarter and could remain a headwind for fiscal '22 if the dollar remains at the current levels relative to other currencies. Adjusted operating margins of 18.1% expanded by nearly 400 basis points year-over-year with expansion in every segment. Our adjusted earnings per share expanded 53% year-over-year to $6.51. I'm pleased with our performance given the inflationary pressures we are experiencing. As we have discussed in prior quarters, we have implemented price increases across our business in fiscal '21, and we expect further increases in fiscal '22. Turning to cash flow, we generate approximately a 100% conversion to adjusted net income with record free cash flow of approximately $2.1 billion for the year. As we go forward, we are confident that end demand will be robust for our products and given our strong balance sheet, we are in a position to do strategic inventory builds to meet anticipated customer demand, given the broader supply chain uncertainty. In FY'21, we continue to maintain our balanced capital strategy, returning capital to shareholders and remaining active in M&A. During the year, we returned over $1.5 billion to shareholders and utilized over $400 million for acquisitions. Going forward, we remain committed to our balanced capital deployment strategy and expect to return two-thirds of our free cash flow to shareholders while supporting our inorganic growth initiatives through bolt-on acquisitions. Before we go to questions, I want to reiterate that we are performing well in this environment, despite challenges in the broader supply chain. Our results for the quarter and for the year demonstrate the strength and diversity of our portfolio with contributions from each of our three segments. Our first-quarter guidance represents the continuation of our strong performance, and we are excited about the growth and margin expansion opportunities as we move forward.

Operator, Operator

Your first question comes from Chris Snyder with UBS. Please go ahead.

Chris Snyder, Analyst

Thank you. In the prepared remarks, you guys said that you expect auto outgrowth to come in at the high end of the 4% to 6% guided range for fiscal '22. So, just want to confirm that, a, I heard that right, and b, that includes any impacts from supply chain? And then what should we make of the company driving low double-digit outgrowth on a two-year stock? My math says you guys outperformed by mid-teens this year, just compared to the mid-single-digit guided range?

Terrence Curtin, CEO

Now, thanks, Chris. You have a couple questions in the question, so thank you for it. The first thing is you're right; just to confirm what you heard. When we're looking at the programs that we won and looking into 2022, we do see something at the high end of the content outperformance range we've given you, at that 6%. We do think that will include any noise around supply chain in that count and outperformance; because like we always say, be careful looking at CPV or content growth on a quarter basis given the supply chain dynamics. What's important to us is, two years ago, we were in the low 60s in content per vehicle. We talked to you about the trends around electrification of the car, powertrain getting electric, as well as autonomy in the car. What's nice is we view this year, we're in the mid-70s in content, and we continue to feel very confident around getting up into that mid-80s range. We're benefiting from the ramp of electric vehicles happening around the world, that's grown 50% this year, as I said. Right now, people are saying that even in what IHS sees to be a flat production environment, electric vehicles are going to grow another 50% next year. We believe we are going to capitalize on it with the program wins we have. This year, about 20% of our automotive revenue is driven by electric vehicles, even though it's not 20% of the total cars made on the planet. This reinforces the content that we've been driving, where we've positioned TE. Certainly, supply chain will make production a little lumpy, but when we look at 2022 and beyond, we think there's a pretty good setup where demand is and where inventory levels are for production, which will also serve as a catalyst on top of the content we tee up.

Sujal Shah, Vice President of Investor Relations

All right, thank you, Chris. Can we have the next question, please?

Mark Delaney, Analyst

Yes, good morning, and thanks very much for taking the question. A question on orders, the book-to-bill was positive but orders were down 9% sequentially. I was hoping you could speak to the linearity of the orders relative to typical trends. Then talk about how TE is interpreting what the order data is signaling? Thank you.

Terrence Curtin, CEO

Sure, thanks for the question. Yes, we have to go back the past couple quarters. We told you there were a lot of orders coming in as people worked with their supply chains. What we started to see is that, in this quarter, the scheduling out continues, which is a good sign as people are accepting the lead times they have throughout the components in their supply chain. Last time I read, I think semiconductors were about half-a-year lead time. So, we see customers looking at scheduling out. While our backlog is clearly stronger in dollars, it's also scheduled out longer. We’re seeing customers adapt to that. The only area that we see any end market softness right now is around auto production, but that's supply chain driven. How those orders moved out aligns with how our customers want to produce and reflects the order trend, which mirrors exactly what's going on. Overall, I think it's getting a little bit more predictable even though it's scheduled out a lot longer.

Sujal Shah, Vice President of Investor Relations

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

Amit Daryanani, Analyst

Perfect. Thanks a lot, and good morning, everyone.

Sujal Shah, Vice President of Investor Relations

Hey, Amit.

Amit Daryanani, Analyst

Hi. As you reflect on your fiscal '21 results, could you discuss how supply chain pressures, component availability, and inflation affected your revenue and EPS for that year? Looking ahead to fiscal '22, do you anticipate these factors will become less of a challenge or remain the same, and what impact might that have on your P&L?

Terrence Curtin, CEO

Sure, Amit. I'm going to let Heath take that because there are a lot of different parts to that.

Heath Mitts, CFO

Sure, Amit, thank you for the question. Certainly, as we progressed over the past 90 days since the last time we spoke, we have started to see from an availability standpoint things improve, particularly with some of our inputs, with resins improving. Now, we are still seeing inflationary pressures, particularly on metals, resins, and probably most pronounced on freight costs. We expect those inflationary pressures to continue into '22. The flip side is that, normally we would see price pressures of somewhere 1% to 2% of erosion each year; in FY'21, that was largely neutral. We did not see those price pressures; we were more back at par. Actually, we expect to see some price increases in '22 as we battle through some of these inflationary pressures, so a lot of moving parts there. Again, I think from an availability standpoint things are improving. We're working through this using price as one of the levers we have to combat the inflationary pressures.

Sujal Shah, Vice President of Investor Relations

All right, thank you, Amit. Could we have the next question, please?

Scott Davis, Analyst

Good morning, guys. Congrats on 2021, it was a great year for you guys, and good luck for '22.

Sujal Shah, Vice President of Investor Relations

Thank you, Scott.

Scott Davis, Analyst

And in that context, the incremental margins you put up, 42% I think it was in Q4, pretty big numbers. If I back into the guidance in 1Q it kind of implies a bit of a slowdown. So, is there any color around that at all or just being a little bit extra conservative? Can we expect the type of incrementals that you've been putting up to be in the ballpark of sustainable?

Heath Mitts, CFO

Scott, I appreciate the question. You're right about the Q4 flow-through, and our flow-through for FY'21 in total was in that range of the 30% to 35% range, which is our expectation. As we move into '22, just to highlight, ERNI, the acquisition, layers in '22 and did not have any impact on our '21 numbers, again, based on the timing of the closure of that transaction. In Q1 alone, if you were to adjust out for ERNI, which will come in at a couple hundred million dollars of revenue but will not add much from an EPS perspective in our first year while we work through the integration and all the value levers we're going to pull for ERNI, that alone will bring our flow-through in the first quarter down to the level that you referred to. If you were to back that out, you'd be up in the 30% range again.

Scott Davis, Analyst

Okay, thank you.

Sujal Shah, Vice President of Investor Relations

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

Wamsi Mohan, Analyst

Hi, yes, thank you. Good morning. Terrence, I know you're not guiding fiscal '22 explicitly, but how are you thinking about the growth in the end markets? And I just want to ask a clarification around the ASB comment that was made earlier on the fall. Some of this outperformance, the magnitude of this right mid-teens for the year or mid-20s for the quarter is well above that 4% to 6% range. Some of that is supply chain dynamics, some of it is ASB, some of it is mix. Anything you can do to help parse those different aspects would be super helpful. Thank you.

Terrence Curtin, CEO

Yes, so let me address that, Wamsi. When we sit here, I want to go back to what I said in the script that we do have a constructive demand environment across our end applications. The only place that we haven't seen a constructive market is in the aerospace side, and that will come at some point, I’m not sure that's going to be in 2022 for us, but that will come at some point. To break it down by the segments a little bit, in Transportation, and like you said, we didn’t guide that. I'll give you how we see external data points. In automotive right now, IHS is saying that it’s going to be around 77 million cars made next year globally, which is pretty flat. That has supply chain constraints in the semi side continuing. Could there be upside? Potentially, if the supply chain gets sorted out. The content that we talked about at the high end of the 4% to 6% inclusive of supply chain noise, we feel pretty good about. In the commercial transportation space, this year has been great for our team. We grew 2X to market. It demonstrates our leading position and the content we’re getting around emissions all over heavy trucks, as well as data connectivity on heavy trucks. Next year, we’re going to have a slowdown in China in the market, which is well known. Commensurate with a flattish environment to slightly down in broader commercial vehicles, we think content will create growth there. I talked about the new EV wins we have on the heavy truck side, which won’t benefit in '22, but further out. In our Industrial segment, recovery feels like it's just getting started. We are beginning to see improvements in medical. Our industrial and factory automation side is very strong. Energy has remained strong throughout the entire '19 forward, and we see that continuing. In that energy business around solar and wind, we think that mid-teen revenue levels can improve there. In the communication segment going forward, you have cloud CapEx increasing another 10% next year. When you think about this and how we have grown 2X to market over past three years, with cloud revenue doubling since 2019, we expect growth on top of that with that cloud CapEx picture. In appliances, consumer demand is still strong, but if the consumer slows then we could face a headwind. Right now, we are assuming that's a flat market globally. Overall, we believe it's a pretty constructive setup, certainly supply chain remains a big piece. We hope our supply chain continues to improve, like we saw over the past 90 days. We'll take advantage of that to build some inventory at the start of the year, to make sure we capitalize on the setup. The bigger piece of our growth this year is content. So, however you want to parcel it, the bigger piece last year had to do with content, and that's what we’re excited about as we go forward.

Sujal Shah, Vice President of Investor Relations

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

David Kelley, Analyst

Hi, good morning. Thanks for taking my question. Maybe to follow up on the 20% EV sales mix in automotive, Terrence, I think you made that comment, the prepared remarks. Just wanted to confirm that, a, that is EVs, and doesn't include hybrids? And then just curious, your EV sales have begun to scale. Is the content per vehicle tracking at that two times relative to internal combustion that you expected, and are you considering any potential upside from there going forward?

Terrence Curtin, CEO

Thanks, David. To clarify, when we refer to EVs, we are including hybrids as well as plug-in hybrids. The 9 million electric units I mentioned globally encompasses both types. This year, our automotive revenue from electric vehicles, combining both high voltage and low voltage, is slightly above 20%. The content is meeting our expectations and is running at double the previous levels. With TE, there isn’t any product cannibalization, as the low voltage components are compatible. When incorporating the electric powertrain, it necessitates charger inlets, which are essential for powering the battery. We are involved with connectivity and power management, facilitating power transfer, and this generates additional content beyond low voltage needs. Importantly, we have secured wins with the top five truck manufacturers on their initial platforms, strengthening our position in commercial transportation. In terms of connectivity, we hold a significant share. Our global customers are evaluating how they can integrate more electrified powertrains into their fleets, and they are turning to us for solutions. We are dealing with voltages around a thousand, which differ greatly from what’s found in cars, along with considerations regarding vibration and durability, particularly in harsh environments. I’m thrilled about these victories, which reinforce our leadership in commercial transportation.

Sujal Shah, Vice President of Investor Relations

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

Joe Giordano, Analyst

Hi, guys. Good morning.

Terrence Curtin, CEO

Hi, Joe.

Joe Giordano, Analyst

Can you hear me? Hi. Okay. Heath, I just wanted to clarify a couple things here. With the orders running arguably a little bit hot and out further and Terrence's commentary about still around $50 million of stuff you'd have liked to have shipped out but couldn't, it was $100 million last quarter. I'm just curious about the inventory build, because it was pretty substantial in the quarter. I get why you'd want to have some protection in place, but I want to square the ability to build that kind of inventory with the inability to get things off the door and high orders. So, can you help me square that?

Heath Mitts, CFO

Sure, Joe. First of all, as diverse as our portfolio is, there are many different products that result in the complexity of our manufacturing environment and our supply chain. It's not just one part and not as simple as simply saying what we can and can't produce. Availability of materials has largely been resins and metals. As I mentioned earlier, resins are improving, while we still work through metals. We anticipate and utilize that resolution will allow us to build some strategic inventory to meet anticipated customer needs due to broad supply chain uncertainty. It's important to note that our demand remains robust, and none of this is a blocking element from our customers. However, when ramp-up will be is yet to be seen. But we want to ensure we meet any ramp from our customers. However, I'm not suggesting this number inventory build will be massive, but we will look to take advantage of a slowdown in the auto production world to help build it.

Sujal Shah, Vice President of Investor Relations

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

Christopher Glynn, Analyst

Hi, thanks for taking the question. Good morning.

Terrence Curtin, CEO

Hi, Chris. Good morning.

Christopher Glynn, Analyst

I am curious about margin outlook generally and communications. Do you expect some margin progress at each segment in fiscal 2022? For communications in particular, comments indicate a flattish appliance market, but second-half comps are off the charts. How should we think about the leverage to the decremental margins for the communications segment?

Heath Mitts, CFO

It's a good question, Chris. As we look at it, we anticipate the 30% flow-through is still what we’re gearing up for this year, but it's probably more aligned with Industrial and Transportation business units. Communications has been performing at high levels, so, it might reflect a little contraction in margins. Overall, I'm not projecting massive decrementals as you're suggesting; the goal remains at about 30% flow through.

Sujal Shah, Vice President of Investor Relations

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

Samik Chatterjee, Analyst

Yes. Thanks for taking my question.

Terrence Curtin, CEO

Hi, Samik.

Samik Chatterjee, Analyst

A couple of clarifications, hi, on auto trends; communications seem to have moderated quarter-over-quarter the auto trends a bit more than the other two segments. Is there something going on there? I know you spoke about strong demand from cloud customers. Also, I think you mentioned in your prepared remarks China automotive orders being up. Is that EV, or is that still like an inventory build? Just if you can clarify those two auto trends. Thank you.

Terrence Curtin, CEO

Yes, I would say for communications, other than just getting a little more normalized and scheduling out, nothing unique in there, Samik. Regarding auto, it's nice to see China auto orders go up. They're also impacted by some of the supply elements occurring globally. This quarter is traditionally strong for China builds, and we're not getting a strong China quarter because of supply chain issues. You should read into that there isn't more or less EV in there as it aligns globally with what we were expecting since Asia is predominant for electric vehicles.

Sujal Shah, Vice President of Investor Relations

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

Joseph Spak, Analyst

Thanks. Good morning. First, just a tough clarification; I don't know if I heard this, but how much are you assuming global production for auto is up, down or maybe flat quarter-over-quarter? Then if you could just talk a little bit about how or receptivity to recovering pricing for commodities maybe by end market how that's going for you.

Terrence Curtin, CEO

Yes. So, first off, on auto production; auto production was about 2 million units light in our quarter we just had versus where we guided. In the first quarter, we're assuming an 18 million unit range for auto production in our first quarter, compared to nearly 23 million from the first quarter of 2021. We’re not guiding for the year, but I believe IHS expects roughly 77 million units for the year, which will be flat year-over-year. In regards to pricing, pricing is very different by our end markets. While I wouldn’t say anybody likes pricing, we're pulling different levers; in auto, we’re in the middle of contract negotiations as we speak.

Sujal Shah, Vice President of Investor Relations

Okay, thank you, Joe. We have the next question, please?

William Stein, Analyst

Thank you for taking my question. I have a query about the communications end market, which has been performing very well lately, particularly in the comms segment. How much of the growth we are observing is specifically tied to cloud service providers upgrading to 200 and 400 gigabit per second intra-data center communications, which we believe has been occurring for some time, compared to a more general increase in capital expenditure? Additionally, does your growth in this area indicate broader market expansion, or does it reflect market share gains from new or improved products? Thank you.

Terrence Curtin, CEO

Thanks for that. The market and growth we are benefiting from are overall in high-speed applications. The bigger growth lever is with the cloud providers; our position across those five providers has remained even as we have gained share. We have not weighted to one particular cloud provider globally versus another, but are benefiting from their capital spending trends, which are increasing by another 10% next year. We’ve continued to see strong double the market rate growth in cloud-related sales this year as well, thanks to content growth that we are anticipating.

Sujal Shah, Vice President of Investor Relations

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

Matthew Sheerin, Analyst

Yes, thanks. Good morning. I wanted to ask a follow-up on the inventory issues. First, looking at your customer base, are you seeing any pockets of inventory build? We're seeing that from some of your peers with their auto customers. Also, if you look at your channel partners, particularly in industrial markets, which have been strong, any signs of build there? From your own perspective, Heath, you talked about building inventory as you get into fiscal '22. Can you tell us how that impacts your free cash flow and conversion rate, which is typically around 100%?

Terrence Curtin, CEO

Yes, Matt. Let me take the part on what we see out in inventory in the world. First of all, for channel partners, I would say our channel partner orders have accelerated over the past three quarters, but they have leveled out now. We have been able to service more to them as our supplies improve, but we have not seen their inventory increase on our product side. Their turn levels this year have remained elevated. When it comes to our customers, we do see some hold back, while other customers remain low in certain inventories. Overall, the supply chain is trying to normalize.

Heath Mitts, CFO

And, Matt, on the question about our inventory bill, it relates to our cash conversion rate and timing. It’s probably more of a first-half issue where some builds happen, then we can bleed that off in the latter half of the year, taking advantage of slower auto production and getting ahead, so we’re ready. I think the timing could pressure the 100% conversion, but we have levers to manage that too.

Sujal Shah, Vice President of Investor Relations

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

Steven Fox, Analyst

Hi, good morning. Just on the 110 basis points improvement since '19 on the operating margins. I was wondering if you could break down sort of how you got there between volumes, restructuring, and maybe some of the offsets, and any implications for the risks of achieving 30% incremental margins this year? Thanks.

Heath Mitts, CFO

Sure, Steve. You're well aware of the restructuring endeavors we have undertaken. Restructuring contributed heavily to improvements, particularly within Transportation. We're benefiting from our previous efforts in Communications when it came to footprint changes. Two significant contributors for improvements have been holding off on price erosion while keeping inflationary pressures neutralized through productivity. Volume plays are significant as well. Overall, I can't give exact percentages per bucket but we are optimistic about maintaining strong flows toward 30% moving forward.

Sujal Shah, Vice President of Investor Relations

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

Jim Suva, Analyst

Thank you so much for the details.

Terrence Curtin, CEO

Hey, Jim.

Jim Suva, Analyst

It's encouraging to see that your restructuring costs are decreasing. I'm interested to know if this suggests that your operating margin will continue to hold at around 30% growth or even improve. With the recent acquisition of ERNI, should we expect an increase in restructuring activities? I'm trying to understand your restructuring goals—it seems that much of the challenging work is behind us, but there may still be timing considerations related to the pandemic.

Heath Mitts, CFO

Sure, Jim. We've discussed this a lot over the years, I appreciate the inquiry. As I see it, most of our larger restructuring items—rightsizing our footprint—are nearing completion. Our bigger restructuring efforts are in response to newer acquisitions. When acquisitions enter the portfolio, they typically come in with multiple sites. We’ll look at consolidating these into our existing footprint or opportunities to migrate at historic TE locations into acquired sites. In short, we are preparing to pivot as we get through our legacy locations and become closer to ERNI-related activities.

Sujal Shah, Vice President of Investor Relations

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

Luke Junk, Analyst

Good morning. Thanks for taking the question. A lot of near-term focus here. I wanted to ask a more strategic question – how do you play offense or position TE to grow above market in areas that have lagged in the recovery, specifically thinking about markets like medical, which is encouragingly just starting to come back right now, and something like COMAIR to continue to become a better position on the backend given the size and scale of your organization versus, say, small competitors in those markets?

Terrence Curtin, CEO

Certainly, during this time, customers have looked for and seen stress around the supply chain from smaller competitors. This benefits larger companies like us. Regarding medical, we haven’t discussed this for the past couple of years due to declining levels of procedures. However, as procedures increase, innovation with our customers has not slowed down. We will talk more about medical growth going forward. In COMAIR, the grounding has hit it hard; while there’s some early discussions around single-aisle aircraft, dual-aisle aircraft is likely further away. Though now we don’t communicate strong growth projects overall; we do maintain a leading position.

Sujal Shah, Vice President of Investor Relations

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

Nik Todorov, Analyst

Yes, thanks, good morning everyone. When you look at your auto sales growth, whether fiscal year '21 or calendar year '21, it looks like sales will outgrow production by more than 20%. Can you help us understand the components within that? I think you touched on this. How much is content versus pricing, how much is FX, and how much is driven by some inventory buildup that you talked about that customer?

Terrence Curtin, CEO

Sure, hey Nik. We did not grow 20% above production — we did have a content outperformance. The market was up about double-digit this year. If you take that and see real elements we were in double digits of content outperformance, with strong EV increases alongside traditional cars, ICE engines we observed a lot of content growth. Price represented a smaller piece. That's what we're excited about the content and where we’re positioned globally with every OEM.

Sujal Shah, Vice President of Investor Relations

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

Rod Lache, Analyst

Shreyas Patil: Hi, this is Shreyas filling in for Rod. I wanted to revisit the question about orders, particularly in the automotive sector. As I look back at 2021, I'm curious how much unusual order activity from OEM customers contributed to the results, so we can better understand the future. You mentioned six points of outgrowth excluding that, but could you provide more context? Additionally, regarding electric vehicles, I know you mentioned an average of $120 of content per vehicle. Considering the growth and some recent wins that surpassed that amount, do you think there's potential for that figure to increase more rapidly over time, possibly exceeding $120? Thanks.

Terrence Curtin, CEO

A couple things there: when we look at production next year, we’re seeing the 6% we expect in content above production; we are including any supply chain noise. Regarding the content, the comments that I made earlier about that 2X growth we do implement both on electric vehicles including hybrids. I think that penetration is continuously going to play out. We’ve shared our pieces of vehicle-specific models, along with average median income cards as well. I like where we’re growing our share and feel strongly about our long-term positioning.

Sujal Shah, Vice President of Investor Relations

All right. Thank you, Shreyas. I want to thank everybody for joining us this morning. If you have more questions, please contact Investor Relations at TE. Thank you, and have a nice morning.

Terrence Curtin, CEO

Thank you, everybody.

Operator, Operator

This conference will be made available for replay beginning at 11:30 AM Eastern Time today, October 27, on the Investor Relations portion of TE Connectivity's website. That will conclude your conference for today.