Q2 2022 TE Connectivity Ltd Earnings Call
Yes.
Yeah.
Ladies and gentlemen, thank you for standing by and welcome to the T E connectivity second quarter 2022 earnings call. At this time all lines are in a listen only mode. Later, we will conduct a question and answer session. If you would like to ask a question. Please press the star key followed by the number one on your telephone keypad.
If you would like to remove yourself from the queue. Please press star one again.
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.
<unk> Shah. Please go ahead.
Good morning, and thank you for joining our conference call to discuss G. Connectivity second quarter 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. 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.
Press release and related tables, along with the slide presentation can be found on the Investor relations portion of our website at <unk> Dot 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 tariffs for opening comments.
And also I appreciate everyone joining us today to cover our second quarter results as well as our outlook for the third quarter of fiscal 'twenty two.
Before he can I take you through the slides details I want to take a moment to discuss the current environment.
And frame our performance relative to some of the developments that we've been saying.
Since our last earnings call three months ago, we have seen some elements of the macro environment become more volatile and.
And specifically, we've seen the invasion of Ukraine, as well as Covid lockdowns in certain parts of China.
While we've seen volatility increase we continue to see strong end demand trends across the markets that we serve.
And I am very pleased that despite the incremental pressures our teams were able to deliver results in quarter. Two that were ahead of our expectations.
Our continued strong performance as a result of how we strategically positioned our portfolio around secular growth trends.
Also the resilience of our global manufacturing strategy, where we have invested to produce in region.
And the commitment of the hard work of our employees across the world.
I'm very proud of our teams as they continue to open broader challenges to effectively serve our customers.
To both manage the present, while also ensuring we're winning programs that will drive future growth for GE.
I'd like to put our performance into perspective, a little bit.
We've made significant progress towards our business model over the past couple of years.
We've been driving top line growth despite market headwinds executing successfully on cost reduction and footprint consolidation plans and driving margin and earnings per share growth. Despite the supply chain and inflationary pressures that we face.
And if you look at <unk> versus a pre COVID-19 timeframe of fiscal 2019.
Our auto sales have increased nearly 20% against auto production declines of approximately 10 million units or 15% and this really illustrates our global strength in the automotive space as well as the content gains we've been talking to you about.
Our industrial equipment and data and device businesses have both grown approximately 50% over the same timeframe and this is significantly above the markets that we serve showing the benefit of where we strategically positioned in these businesses as well as the strong execution of our teams.
Yes.
I do think it's important to separate signal from noise as you look at <unk> from an investment perspective.
While we are in a very noisy environment near term no.
Longer term growth signals across our portfolio remain positive.
These signals are secular in nature, giving us confidence that we will continue to perform in line with our business model through cycle as an industrial technology leader.
We have all three segments contributing to our performance.
For example in our transportation segment, we are the established global leader for EV connectivity solutions.
Over the past year the value of our design win pipeline grew by over 50% and we are designed into every major electric vehicle in hybrid platform with customers around the world.
This positioning has been driving and will continue to fuel our content growth and enable consistent above market performance in our transportation segment.
If you turn to our industrial segment, we are in the heart of the industrial automation trend and have grown our sales at double the rate of capital expenditures as the markets recovered from Covid.
We've been working with industry, leading customers to develop engineered solutions targeting higher growth robotic and safety applications and this is resulting in our robust growth pipeline that you are saying.
And in our communications segment, we are expanding content and high speed cloud applications and gaining share in artificial intelligence deployments as customers implement workload architectures to make data centers more efficient.
And these are just a few of the secular trends that we have positioned the portfolio around which will drive future growth and we remain excited about the long term growth and margin expansion opportunities, we still have in front of us.
So now let me highlight a couple of few additional takeaways from today's call.
Our second quarter results were record quarterly sales and adjusted earnings per share with strong results in each segment.
On a year over year basis in the second quarter, we delivered organic sales growth of 8% and adjusted earnings per share growth of 15%.
Along with adjusted operating margins of 18, 4%.
Margins expanded in each segment year over year as our teams are effectively managing pricing and cost in an inflationary environment to drive the margin performance across our businesses.
The other key highlight is that the demand environment continues to be strong and we will talk about it and it's evidenced in our orders, which were $4 5 billion in the quarter.
Our book to Bill was well above one for each segment and it reflects the continued strength across our markets.
The other highlight about our organic performance is that in the second quarter. It shows the strength and the positioning of the portfolio with our industrial and communications segment growing over 10% and 20% respectively.
And our transportation segment growing 5% despite auto production declines in the quarter.
We continue to benefit from the ramp of new electric vehicle platforms, which will continue to drive content outperformance for our transportation segment.
And the last highlight is that we are expecting our quarter three sales to be around $3 9 billion.
And this does reflect continued strong performance.
We have a strong demand environment, coupled with the broader volatility I do want to stress our ability to produce will remain a key factor in our near term sales performance.
Yeah.
So let me turn now and I'll provide some additional color on some key end demand trends as well as talk about the supply environment.
We are continuing to see broad strength in global capital expenditures that relate to factory automation cloud and data center efficiency as well as renewable energy sources.
And demand for autos remained healthy and is significantly higher than what the Oems can produce and this provides a setup for future auto production increases as supply chain bottlenecks begin to resolve.
While we see a demand environment that remains positive the invasion of Ukraine, and Covid Lockdowns in China, our new developments versus 90 days ago.
And let's face it the supply chain challenges and inflation inflationary pressures continue to linger.
On the supply chain the challenges around material availability in flow I would tell you about the same as 90 days ago, but we have seen an uptick in inflationary pressures.
I am pleased with how our teams are continuing to manage the supply constraints to meet our obligations to customers.
And Theyre also working additional price increases to partially offset higher costs. So that we can maintain margin performance in each segment.
We believe that we are differentiated with our global manufacturing strategy and ability to produce and region and this is helping us to enable the growth and share gains across our business. During these volatile times.
Now with this as an overview, let me get into the slides and discuss a few additional highlights that are on slide three.
Our quarter two sales of $4 billion were up 7% on a reported basis and 8% on an organic basis and adjusted earnings per share was $1 81, which is up 15% year over year with both being records as I mentioned.
From a free cash flow perspective, we generated approximately $615 million in the first half and we returned approximately $670 million to shareholders in the second quarter.
And we did increase the pace of our buybacks during the quarter.
If I turn from financials for a minute.
I'm also impressed that we continue to be recognized for our ESG initiatives with TV being named among the world's most ethical companies by Ethisphere for the eighth consecutive year.
I am pleased with our commitment and continued progress of our ESG initiatives and also our employees are really leaning in and being engaged on these important initiatives across CE.
Okay.
So let me again touch upon our guidance for the third quarter.
We do expect sales of approximately $3 9 billion.
And this will be up 1% on a reported basis and 3% on an organic basis versus the prior year.
This guidance does include approximately 300 basis points of year over year headwinds from the expected COVID-19 related shutdowns in China that we expect in the quarter.
And we do expect adjusted EPS to be approximately $1 75 in the third quarter.
Okay.
So if you could I'd like you to turn to slide four and I'll get into the order trends and market's a little bit further.
Okay.
At an overall level, our second quarter orders were $4 5 billion with.
With a book to Bill of 113.
And it highlights the strong demand that I've mentioned already.
While <unk> is not typically a backlog business. We are in an environment, where you need to look at both bookings and backlog to get a full picture of demand.
Our backlog is up 40% year over year and is up significantly in every segment.
Importantly, we continue to see stability in our backlog in each segment and our customers continue to provide order visibility beyond the current quarter to ensure supply certainty and these ongoing volatile markets.
In our transportation segment.
We saw order levels increased sequentially influenced by concerned around the recent developments in Ukraine in China.
Global Auto production was in line with our expectations in the second quarter at approximately 19 million units and.
And we expect auto production declined slightly in the third quarter on a sequential basis.
The trends around our content remains robust as we continue to benefit from increased electronic vacation and higher production of electric vehicles, and we expect that electric vehicles to be up approximately 30% this year on production.
Given the volatility we're seeing in global auto production and the comparisons that can result, as we move through the second half it.
It is important we look at content per vehicle as an additional long term metric.
Our content per vehicle has expanded from the low sixties range in pre Covid times to roughly $80 in fiscal 2021.
As we look forward, we expect continued expansion in our content per vehicle from the first half to the second half of this year.
When you look beyond the near term noise in the auto supply chain, we continue to see a favorable setup for a longer term auto production growth with healthy end demand and dealer inventories at remain extremely low.
Okay.
Looking at our industrial segment orders.
We saw another quarter of strong orders with a book to Bill of one to two.
We continue to see an improving backdrop with increased capital expenditures for factory automation manufacturing capacity and renewable energy.
And these trends benefit both our industrial equipment and energy businesses.
We're also continuing to see improving order trends in the comm air as well as favorable conditions in our medical business and we expect to see favorable year over year revenue comparisons in those businesses later in this fiscal year.
Yeah.
And lastly, and communications orders continue to reflect strong demand as well we had a book to bill of one <unk>.
In data and devices, we are seeing a robust outlook for cloud capital expenditures and we continue to gain share.
As we mentioned last quarter, we continue to expect softening in our appliance business from the first half to the second half of this year.
And just to add some color of what were seeing geographically and I'll do this on an organic basis sequentially.
In North America orders were up 12%.
In Europe , they were up 16% and in China, our orders were down 4%.
Yeah.
So with that overview about orders in markets and what we're seeing let me get into the segment results that you can see on slides five through seven and I'll hit on some of the highlights in each of the segments.
In our transportation segment, our sales were up 5% organically year over year.
Our auto business grew 5% organically versus auto production declines in the mid single digits.
This continues to show the separation of our sales performance versus the market, which is being driven by our leading position in electric vehicles and their increased adoption.
In commercial transportation, we saw 5% organic growth driven by North America and Europe .
Even though the market in China is still going to be down this year.
We continue to see significant outperformance in all regions driven by content growth and share gains.
And in our sensors business, we were roughly flat organically and we continue to see strong design win momentum and transportation applications.
If you look at earnings in the segment adjusted operating margins were 18, 2% as our teams continue to execute well and implement price increases to partially offset the inflationary.
Generic pressures.
Yeah.
So let me turn to the industrial segment, where sales increased 11% organically year over year.
And the industrial equipment business, our sales were up 27% organically with double digit growth in all regions and continued benefits from increased capital spending and factory automation.
In energy, we saw 5% organic growth driven by increased penetration in renewable applications.
And then our AVM medical business, our sales were both roughly flat and as I said earlier, we expect improvement in both markets and more favorable comparisons as we go forward.
Yes.
At the segment level adjusted operating margins expanded year over year by 280 basis points to 15, 3% driven by higher volume price actions and strong operational performance.
So let me move to the communications segment.
As Youll see on the slide our teams continue to execute well, while capitalizing on the growth trends in the markets that we serve.
Sales grew 23% organically year over year for this segment with growth in each business as you can see on the slide.
And our data and devices business, we saw market outperformance driven by content growth in high speed cloud and share gains in artificial intelligence applications, which are aimed at improving energy efficiency in data centers.
This continues to illustrate how we are enabling a positive impact on carbon emissions across our portfolio through our products and our technologies.
And our appliance business. We performed ahead of our expectations and this is despite the expected declines we saw in the China markets.
We saw growth in North America, and in Europe with continued share gains enabled by our manufacturing strategy to produce close to our customers.
This resiliency is proven to be a differentiator as customers navigate the challenges in the macro environment.
And from an earnings perspective, our communication teams continues to deliver outstanding performance with adjusted operating margins of 24% up 330 basis points versus a strong quarter in the prior year.
Because of the heavy lifting we've done in this segment around cost reduction and footprint consolidation. We expect segment adjusted operating margins to remain above 20% through the second half even as the appliance market moderates.
So with that as an overview of the segments in the market. So let me turn it over to Heath to go into more details on the financials and our expectations going forward.
Thank you Terrence and good morning, everyone. Please turn to slide eight where I will provide more details on the Q2 financials.
<unk> operating income was $736 million with an adjusted operating margin of 18, 4% GAAP operating income was $705 million and included 21 million of restructuring and other charges and $10 million of acquisition related charges.
We continue to expect restructuring charges of approximately $150 million for the full year as we continued to optimize our manufacturing footprint and improve the cost structure of the organization.
Adjusted EPS was $1 81, and GAAP EPS was $1 71 for the quarter and included tax related items of <unk>.
<unk>, we had restructuring acquisition and other charges of approximately eight.
The adjusted effective tax rate in Q2 was approximately 19%.
For the third quarter, we expect our adjusted effective tax rate to be roughly 20%.
And we continue to expect an adjusted effective tax rate around 20% for the full year.
Importantly, we expect our cash tax rate to stay well above our adjusted ETR for the full year.
So, let's turn to slide nine.
Our results that you see on the slide reflect the strong execution of our teams and how we have strategically positioned our portfolio.
As Terrence mentioned, we delivered strong results in each segment.
Sales of $4 billion. The company record were up 7% reported and 8% on an organic basis year over year.
And just to provide some color on our organic growth approximately one third of our organic growth was driven by the price increases.
Also currency exchange rates negatively impacted sales by $116 million versus the prior year.
As we look forward into Q3.
We expect currency exchange rates to be sequential headwind of approximately $50 million.
And a year over year headwind of approximately $150 million due to the strengthening U S dollar.
As you May recall last quarter, we discussed the impact of currency exchange rates for our fiscal year and we now expect our fiscal 'twenty two impact between four and 500 billion.
The headwind from FX. This is about 100 million worse than we were 90 days ago with the majority of that additional impact occurring in our second half of our fiscal year.
Adjusted EPS of $1 81 was up 15% year over year and represents a company record as mentioned earlier.
Adjusted operating margins were 18, 4% and I am pleased with the performance of our team given the incremental inflationary pressures, we have seen we're pulling price levers across the business to help partially offset these pressures, while we were not able to offset these cost dollar for dollar we are able to recover approximately two thirds.
Through price and the remainder through productivity initiatives.
As you would assume we will continue to respond with pricing levers to mitigate the impacts in this environment.
Turning to cash flow in the quarter.
Cash from operating activities was $413 million free cash flow for the quarter was $242 million.
As we mentioned last quarter for the year over year trend in free cash flow reflects strategic inventory builds.
Sure.
Yes.
We expect free cash flow to increase significantly in the second half of the year versus the first half and expect inventory levels to stabilize as we move through the year, we increased the pace of our share buyback in the quarter and returned approximately $670 million to shareholders through share repurchases and dividends through the first half.
We have returned over $1 billion shareholders, we remain committed to our disciplined use of capital and over time, we still expect two thirds of our free cash flow to be returned to shareholders and one third to be used for bolt on acquisitions.
So before we go to questions I want to reiterate some of the key points that we covered today.
We are continuing to execute well in a volatile environment demonstrate sales growth marsh margin resiliency and EPS expansion.
We remain in a strong demand environment as evidenced by our orders and backlog and the ability to produce will be a key factor of our near term revenue performance.
We are strategically positioned CE around well recognize secular growth trends and we continue to generate performance ahead of the markets we serve.
Our teams continue to prove their ability to execute in this volatile environment effectively serving our customers, while managing price and cost dynamics and we continued to demonstrate resilience through our global manufacturing strategy.
So with that let's now open it up for questions.
Roger can you please give the instructions for the Q&A session.
Thank you at this time I would like to remind everyone in order to ask a question press star one on your telephone keypad.
In order to have time for questions. All questions. Each participant is limited to one question you would like to ask a follow up question. Please press star one.
Tim Mchugh.
We will take our first question from Chris Snyder at UBS.
Thank you. So my question is on order trends.
Transportation orders up 18% sequentially, how should we think about the drivers here of between improving demand, but also likely longer duration ordering as supply chain peers are picking back up and then from Ohio level. The company talked a lot in the prepared remarks about the secular transformation of the biz.
So when we looked at the $4 $5 billion of orders are there any metrics or color you could provide around how much of this is coming from the secular growth business lines, whether it be evs magic call automation or data centers just to help get more comfortable around the ability to drive continued growth.
In a macro slowdown thank you.
Sure. Thanks, Thanks, Chris.
There is two questions there so let's start with the first one.
As I said on the comments right now the demand environment remains strong and you can look across all three segments certainly saw transportation pick back up I do think some of that was a reflection of people trying to make sure. They had supply chain certainty with what was going on in eastern Europe and in Ukraine.
Which a number of our customers have operations in Ukraine at tier one customers and people really working hard to make sure. We get continued continuity of supply.
The other thing that you certainly had was also with some of the China Lockdowns and the China Lockdowns, we've been dealing with since.
Even in the second quarter, certainly in southern China, but what we're experiencing in Shanghai is obviously.
More widespread than what we've been dealing with today.
And I think the other key thing when you look at these orders and additional what I said is I want to go back to a point, which I think is very important.
The amount we can produce will be the driver.
Our revenue and even when we look at our performance in the second quarter. It was more about our team's executing well to be able to get more out and I would say it was more incremental demand we're still in our supply chain constrained environment.
The other thing about your question on the <unk>.
On that I mentioned in the.
Pre remarks.
I do think it's important also look at backlog and I know thats not something we like to talk about a lot, but it is something as we continue to see customers try to get more certainty also knowing what's going on around the world. We do see customers, placing orders out to make sure. They are securing supply certainty and let's face it over what we do.
You don't want to be shutting down a line over what our content is in any application. So we continue to see customers place orders out it is across.
Hello, <unk> businesses and the other element that we always look for is are we seeing push outs or cancellations in the backlog and we are not seeing meaningful push outs or cancellations anywhere. So it really is an indicator that the demand is strong.
We feel good that youll see savings or like the industrial businesses continue to improve from the industrial recovery. We've been talking about places like appliance, we do see moderating it started in China, we expect that to moderate through the remainder of the year, but net net it is a constructive demand environment.
As you get down to your second part of your question about.
Orders in those secular trends.
Do you see that in how we talk about our guidance and some of the things that I mentioned.
So the orders that were seeing do reflect those secular trends I don't have numbers here in front of me to tell you the orders by each one of them, but when we talk about our guide and our content outperformance. Let me tell you with the program wins as well as the orders as they are coming in as these are typically Newark custom programs. It is things that are coming in and.
Driving the orders as well.
Okay. Thank you Chris can we have the next question. Please.
Next we will go to David Kelley with Jefferies.
Hey, good morning team.
Hoping to dig into the auto content per vehicle drivers and I believe you referenced an expected uptick from first half to second half I think we are content tracking in the low eighties trailing 12 months versus your records that low sixty's numbers in 2020.
So can you walk us through that the EBITDA impact of content over the last two years and how we should think about EV momentum and contribution into the second half and then any color on the expectations of broader mix and inventory dynamics first half second half would be helpful as well.
Okay.
Thanks for the question, David and let me get into I want to reiterate what I said in my.
Prepared remarks.
And when we talk about automotive content and what <unk> done one of the things that I always think is important in TEP as we have content increase due to electronic vacation, which has happened on both combustion and electric vehicles and then we also get the kicker as EV adoption occurs and I think it comes through when you think about.
Our auto revenue being up 20%.
Versus 2019.
While auto production of 10 million units.
And really it really shows where we positioned.
Our portfolio of investments, we've been making for award of a decade.
And the $60 I referenced on the comments that 2019 so.
2019, our content was around 60 low <unk>.
In 2021, we were at 88 were run at above that as we continue to grow content and.
And if you look over this period certainly the number of ice vehicles made on the planet is down.
The number of EV vehicles are up significantly and if you look at content going from 60 to 80.
About 60% of that content increase is due to electric vehicles. There are increased adoption as well as our content both of those items.
But the other 40%.
As content growth on electronic vacation.
Across vehicles and that includes ice cores. So we have content increase on both types of platforms over this period.
Certainly you get the kicker that we've always talked to you about around of Evs grow faster our contents bigger honest.
And youre going to continue to see that because let's face. It EV adoption is up probably up to about 12 million units this year from $9 million last year.
And Thats why we get so excited.
The other thing I do want to highlight is.
Our products are really differentiated and we were in a business review and right now we're up to about 1000 patents that we generated around EV technology globally.
And we don't typically talk patent law, but when you think about the innovation, we bring I talked about the number of programs that dollar value programs in the prepared comments.
This is happening whether it's a charger inlet the connectivity that happens close to the motor what's happening on the sales the connectivity you need there as well as some of the power conversion that you need to occur between the battery in the motor and they are things that we benefit from all of that and then where we get sensor elements around current sensing also.
Creates a kicker.
So I really think youre going to continue to see as Evs continue to adopt that as a contest and our teams are scaling.
And that's something we've also have to do not only how do we innovate how do we get the manufacturing done and I think youre going to continue to see that.
And that content per vehicle grow and I also believe there is a good setup as production gets better that auto production to get into a growth mode again at some point in time, which will be an additional kicker.
Okay. Thank you David we have the next question. Please.
Next we'll go to Mark Delaney with Goldman Sachs.
Yes, good morning, Ian and thanks, very much for taking the question, which is on margins you mentioned cost is going up.
You spoke about being able to recover about two thirds with pricing and the remainder with productivity.
Could you give more details in terms of the timing to fully execute on those mitigation measures and is there going to be some period of time, where margins are going to be temporarily depressed and if so by how much as you work through some of those are offsets.
Offsets to the cost pressure.
Mark This is Heath I'll take the question on margins, we will certainly listen we're we're holding our head.
In this environment as you mentioned this is a very heavy inflationary environment for us that impacts metals.
Metals, and resins and trades and utility energy prices. So.
We're feel pretty good about our ability to hold our head in the mid eighteens range of operating.
Operating margins.
I would tell you as you mentioned, we recovered about two thirds of that for through price.
That will be the story as we work our way to continue to work our way through the fiscal year as well and you have to remember and I know Mark you know us well.
In a normal.
Environment, our business model.
Contemplates more of a negative price environment based on volume commitments and so it's not uncommon for us to kind of before we get into your outside this inflation environment should be down a point point and a half a price a year, we've moved that up into positive territory and as I mentioned on the call. A represented about two represent about one third of our overall organic growth.
To frame up a little bit what that looks like from a price and yes.
That's still only covered about two thirds of the inflationary pressures, which are significant so our business model contemplates certain things and in this environment. We're happy we're able to pass on the amount of price that we can.
Our footprint, we've done a lot of work on that over the last few years as you know and.
And especially you see that come through on the communications footprint, where we have optimized that in at these volume levels. We continue to print margins in the mid mid <unk> in terms of operating margins and we've been going through a similar type of activity as you know within transportation and industrial or <unk>.
Last few years in some cases, we're getting close to where we need to be in a regional footprint is important to be close to the supply chains of our customers and I feel good about.
That impact that that's having for us to be able to hold our head here.
In terms of going forward I would say, we're kind of in that same range.
Don't anticipate called.
Calling out a temporary depressed margin relative to the timing and as part of your question. We will continue to power through this and.
Take advantage of the opportunities, where we have and continue to optimize our cost structure.
Okay. Thank you Mark we have the next question. Please.
We'll go next to <unk> Mohan at Bank of America.
Hi, yes. Thank you Terrence can you share some more color on the China Lockdowns I know you quantified the impact of about $100 million, but.
How much of that is supply versus demand.
What is happening with the demand trajectory in China, and how much impact you do you expect through the rest of the year.
And then on pricing.
I know he said that there was about a third of the growth is benefiting from pricing almost wondering if you could put a lens on what percent of your portfolio, you've been able to change pricing on.
As it pertains to auto is there more to come thank you.
Sure Romsey. Thanks for the question. So let me start with the China element first then.
Debase, everybody you know China is an important market for us it's about 20% of our sales.
We do not see whats going on in China as a demand issue.
Our orders in China have been above $900 million four 5% to six quarters now and even in the last quarter. Our book to Bill was 107, so from a demand perspective, we don't see there being a demand problem.
But when you think about the Lockdowns and like I said earlier, we've been dealing with lockdowns because not all our factories are in the Shanghai area, we have factories in the north up in Qingdao, we have factories down in southern China around Shenzhen, Guangzhou, Shonda and really what we're seeing here is you've got to break it into pieces, where the customers.
Okay did we have customers that are in shutdown.
Where are some of our suppliers and then also how do we move things around.
China, because our China business is really to serve the China manufacturing market is not an export business to the world.
And really what we're dealing with is we have factories that are running they arent running full tilt we have customers that are trying to get back up and running.
And the number that we laid out here today.
It is really what we know from a bottoms up.
If the lockdown would and I would hope we would be able to recover up.
The amount that we're missing here in quarter, three but it is more of a logistics and a supply getting to the customer than it is actually our ability or demand destruction in anyway. So demand is strong, but certainly a very fluid situation.
And a very important market for us.
On pricing.
Your second part of your question.
When you look at pricing, we're getting pricing across all businesses in all segments.
So when you talk about what element of the portfolio are we getting pricing on it all of it it is different degrees it depends upon the customer certainly in.
In areas like distribution will be putting another price increase into effect here in July with the increased inflation certain and those with direct customers were having direct contractual discussions.
Started last year and they're continuing.
And I think it's proven between the pricing and the productivity that we've been able to drive it shows up in the margin that shows the breadth of it. So certainly we have to get it because of the breadth of the inflation that we've seen and we continue to experience.
Okay. Thank you once we have the next question. Please.
And next we'll go to Amit <unk> at Evercore.
Yes.
Good morning, and thanks for taking my question.
I realize he doesn't provide a formal full year guide, but you spoke about the metalworking noise and they want to use a lot of noise out there.
Thank you perspective on what are you seeing in the back half of the year that multiple Ross.
In terms of how things will play out I'd love to just get a sense on what are the puts and takes would tell from a revenue and cost perspective in the back half.
Thanks.
Yeah, and then Youre right, yes, so I'll give you some tidbits here Amit.
But certainly you are right. We are only guide for the third quarter is due to the volatility.
I think you have to start with demand is strong.
While we have.
A little bit of an impact here due to China.
Our second half revenue is going to be driven by what we can get out of our factories, we still believe that and it's how do we get material how do we get to produce how do we get a ship because we do want to continue.
Continue to make sure we help our customers with the supply situation.
If you look at it by business, we're going to continue to probably say youre going to see industrial improve I've talked about comm air and medical improving certainly industrial staying strong in energy.
We will see our <unk> segment to moderate due to appliances and thats not new that has nothing to do with the recent market. That's really what we've expected and we've talked to you about.
And I think transportation is probably going to be moving sideways more due to auto production demand and content. We do we would have thought probably 90 days ago auto production would improve in the second half with some of the things that are going on and we sort of expect it will probably be running around $19 million.
Units a quarter.
We do have as Heath talked about currency I would ask you all to make sure youre picking up the currency impact.
Incremental headwind of about $100 million in our second half.
And some of the wildcard will be around China.
If the Lockdowns are able to get down it'll be how do we recover the customers recover that if demand stays where its at could that be some recovery in the second half of this 300 basis points that we estimate today, but.
But overall it remains constructive and we're going to continue to do the productivity and pricing actions that Heath and I've talked about so net net I think you could see us getting back more to the quarter two level plus as we get to later in the year.
Okay. Thank you Amit we have the next question please.
We'll go next to stemming Saturday at J P. Morgan.
Hi, Good morning, Thanks for taking my question I guess I just wanted to ask on data and devices, we get often asked by investors about how long can this sort of trend that you're seeing in data and devices continue and maybe if you can flesh out I know you spoke about sort of the highest speed cloud applications, but please if you can flesh out the curve.
Then growth story, there between more number of connectors going into some of these applications over time versus where are you seeing sort of more appetite to buy higher fee code or higher content connect those little tiny home with a perfect and growth is really more volume versus higher featured our highest specification connectors.
Yes. Thanks for the question and I think when you look at our D&B business. The important metric you should be looking at is really what's happening in cloud capex.
<unk> Capex is the important driver cause as our cloud customers look at it they're really trying to solve a couple of problems certainly not only the consumer need and enterprise need for cloud infrastructure, but also they're trying to solve operating efficiency.
<unk> is one of the biggest drivers that they have is not only the need for speed and compute but also how do they reduce their economic footprint and cloud Capex continues to be strong it actually increased a little bit and we continue to see that be strong. The other thing thats benefiting our content is not only just cloud cat.
And you see us growing ahead of cloud Capex. We are also winning not only on the speed side, but how do we help our customers solve some of the energy efficiency operating cost issues. They are trying to tackle because data centers use so much energy and I know Aaron has shared some things around our terminal bridge product, but also as they move to AI there really.
Trying to say, how do they increase computational power with some of their workload architectures and that benefits us from a content perspective, and while we do have share gain happening that content element is just as important.
Across all facets of the compute in the store and move elements of cloud.
I think youre going to continue to see based upon the cloud capex trends and that's the key driver to look out and we can drive outperformance versus that cloud capex due to really how our engineers are really tucked into our cloud customers.
Okay. Thank you Mike can we have the next question. Please.
We'll go next to Matt Sheerin Stifel.
Yes, thanks, good morning.
So I wanted to get your take on the inventory environment. Your inventory was up like your peers, but we're also seeing inventory decline within EMS.
OEM and even the auto guys. So what is your sense of customer inventories and did you see any pull in.
In Q in your remarks quarter due to.
Anticipation of Lockdowns et cetera.
I wouldn't say, we saw Poland, Matt because in many cases, we arent what we can produce people are taking.
So it comes back to the what I've been saying throughout the call about hey, what we can produce our customers want.
The one area, where we always have the most visibility is and our distribution partners and one of the things that we've been seeing with them is they're still light on a day's perspective versus pre COVID-19 and what they would normally target so across our partner network, which is about 20% of our sales. They typically target about 180 days.
<unk> of inventory.
They are still running in the $1 50 160 <unk>.
Overall, so that's something we look at because they can be a pretty concentrated proxy to say as inventory.
Getting to flush out there.
And I would tell you you know we did see orders increased due to some of the certainty people were trying to get with some of the increased volatility we did not see pull ins and really how we produce will be the dictator of revenue.
Okay. Thank you Matt can we have the next question. Please.
Next we'll go to Joe Giordano at Cowen.
Yeah.
Hey, guys good morning, Hey, Joe.
There was a comment that I believe GM may.
And not to get specific about one customer or anything, but just more of like an overarching theme that on ice vehicles are going to use one third or one.
One third less of like unique parts I have no idea if they're talking about like we're in the car thats going but I'm just curious if that's a risk going forward to legacy platforms were like maybe.
Products, where you can have more more pricing power and leverage because their custom engineered become less and less prevalent.
Hey, Joe Joe could you could you.
Pete what GM said I've missed what you said there on the one third of what.
So they said that they're going to use one third less unique parts in like ice platforms going forward.
Okay.
Look at that certainly.
You see the innovation around ice platforms.
There has been less innovation put into it you look at engine development has scaled back. So what you really are getting on the ice.
Vehicles, you really have the auto companies very much focusing their effort on obviously EV <unk> you also get into the data and autonomy type trends and really on the ice vehicle.
It has become a little bit more of a maintain.
That being said you do need to think about what <unk> does and what we do we also play into feature safety features and that really drive whether it's safety feature infotainment features emission features those types of things really where we get scale and even getting more standardized we have many parts that are standardized on a car.
That create tremendous scale for us so going less unique an ice vehicle is not bad for us It actually provides us with scale and in some cases, we're seeing them look to us to be that partner to help get that standardization.
And I would go back to what I said on the call are.
Our content growth and a nice vehicle is still strong even though you have the innovation turning towards the next generation <unk>.
Electric vehicles, so we do not see cannibalization.
And the move to EV and we also continue to see that electronic vacation trend and I would just ask you to think about your cars of what you feel from a feature how features change and each time youre doing that youre typically getting into more data in the car things that are going to want more processing to get to more fuel efficiency and a nice vehicle could be.
Safety features and all of those create content per day, because youre into the electrical architecture of a vehicle, whether it's low voltage an ice engine or your high voltage and on electric vehicles.
Okay. Thank you Joe the next question please.
We will go next to William Stein of tourists Securities.
Great. Thanks, I'd like to ask a question about capital allocation.
I think about a third of cash flow would be targeted towards bolt on acquisitions.
Im hoping you might just remind us about.
And market focus that we should expect to see such transactions and.
Your propensity today give it.
Somewhat lower valuation stock markets pulling back I wonder if that's.
Influencing it any way the likely pace or ability to execute a deal. Thank you.
Thanks, William I'll take your question.
Longer term, which is kind of how we think about the two thirds back to shareholders via share repurchase and dividends and then one third back via M&A.
That is a that is a long term view over a cycle right. So youre going to have periods of time, including the ones. We're in right now where we see dislocations in our stock price and we see ourselves as a better opportunity to buy and we are spending accordingly on that and we haven't been.
<unk> has many deals get done.
In the spaces that we're focusing in on but Theres still a fair amount of fragmentation out there for bolt on activities across I would say about two thirds of our of our end markets.
And there is a focus.
On the spaces that you've seen us do deals and whether that's an industrial or certain things within medical and.
In our high speed data and some of the activities that we've undertaken more recently there.
And it's pretty broad the net that we cast to look at transactions in any given time you can imagine we're looking at.
Half a dozen or so and most of which don't get to the finish line for a variety of reasons, but we're very active in that front I would say the pullback in the stock price, we have not seen a meaningful impact of that impacted on valuations here in the near term.
What that does over the long term, we'll see.
Most of the things, we do look at our public companies. So.
And there tends to still be a fairly decent appetite out there to deploy capital from us as well as others. So that has continued to inflate the multiple sub.
So we have to be selective we have got to be smart, but with what we do with our owners money.
And make sure we're getting good financial returns and things that make strategic sense for us, but but we're active out there.
Okay. Thank you well we have the next question. Please we will go next to <unk> at Wolfe Research.
<unk>.
Hey, Thanks, so much for taking my question I just had two.
Vacation so.
It looked like Ottawa growth. This year is going to be better than the six points I mean, you're already doing about 10 <unk>.
Tom.
Is that mainly related to favorable pricing and should we be thinking about the underlying content growth.
And that six points.
Level and then the second one was on the Q3 guidance slide 12.
Looking at the contribution margin on the $209 million.
Year over year operational performance was pretty low it's only about <unk> <unk> to EPS.
Maybe like a 5% EBIT contribution margin and Im just curious how much of that is being driven by COVID-19 lockdowns and the cost impact.
Okay.
Yes, let me take the first half and I'll ask Heath touch upon your guidance question here on the first half we are running well ahead a lot of that relates to you know EV production is very strong. This year. So you will have points, where depending upon where EV production is versus ice production can drive that outperformance and like I said, we would.
Anticipating if you look at our content per vehicle will continue to move up in the second half versus the first half.
Heath do you want to take.
The second part of his question, Yes, sure Q3 contribution margin.
Would.
Steer you to.
Really look at how we've been trending sequentially in the mid eighteens 18 ish.
And plus four operating margins if you recall a year ago, we were pretty upfront that we were <unk>, our fiscal Q3, a year ago, which was over 19% Oi was trending fairly hot there were some timing issues between the second and third quarter of last year. If you go back and look at those those margin swings. So you kind of have to.
A look at those together to get us to get a fair view versus this year's Q2, and Q3, which is a little bit more consistent but I would tell you that there is no doubt year relative to the Lockdowns I mean, there is some pressure that's put on obviously, how we quantify the top line.
But about 300 basis points to the total company relative to this trend of Lockdowns and that does come at a in a region, where we make very good margins and so it's something that does have a mix impact as we think about the roll up to.
To a degree so.
But we're hammering through it and I don't feel like it's something that's permanent and I think as you get through and you look at our full year, the full year contribution margin, even including absorbing the early acquisitions still should be.
With a three handle in front of a $30 30 unchanged, maybe a tad better than that as we work our way through the full year.
Thank you <unk> can we have the next question. Please.
And next we'll go to Jim Suva Citigroup.
Thank you can you hi, Jim.
Greg can you just help us bridge that.
Orders.
Pricing and what I mean by dabbled with everyone knows pricing is going up logical but everybody puts in a lot of orders to those.
Increased pricing.
Put in some type of escalators are variables and just if you can kind of talk about those dynamics and how they come about.
Well, Jim it's a little bit.
Don't want to be elusive to your question, but it is a bit different with our distribution partners. We've also been repricing backlog.
So even if they put orders and we have been repricing backlog due to the broad escalations that we have when you come into our large customers that's part of a contract negotiation.
We have not been doing surcharges in adders like that it's been more around price increases and that's.
Like we've said here today, it's about cost recovery.
So we're going to continue that certainly with the uptick that we've seen we have more discussions we need to have on pricing and we're going to be further.
Pricing increases into the channel here come in July .
Thank you Jim can we have next question. Please.
We will go next to Chris Glenn at Oppenheimer.
Thanks, Good morning.
I wanted to ask about factory automation and industrial sort of similar to the question about.
Measuring the longevity of the potential data devices cycle.
There are capital cycles.
Of course, but youre talking about robotics electrification and safety.
I think people contemplate maybe some longer term labor constraints. So how would you view the sort of.
Cyclical versus durable kind of secular components of what youre seeing in industrial growth. These days.
A couple of things clearly you got to start with where is the capital cycle at <unk> and we will similar to the DMD comments I made around cloud Capex I do think there will be an element that we will follow industrial capex, with especially where we continue to position our industrial.
<unk> business and I think there is an element when I talk about that business, while I talked about.
Some applications, we focused on it's also where we've done acquisitions to get deeper into.
We did the inner contact acquisition a number of years ago. We did Ernie we did entre lack and these were things that were really about how do we get deeper into the trend because when you deal with factory automation as well as kind of the labor element. What are you trying to do you are trying to get data off of machine Youre trying to get to the machine to have more intelligence that app.
It can do things that humans can do machine learning as well as preventative things and that all starts with are you getting data off the machine and that's that's with what we do whether it's from a sensing where connectivity perspective.
So I do think the capital spending element of positive construct and I think what youre going to continue to see similar to what we've seen.
With our data and device business, so youre going to see content outperformance above that capital Capex trend.
And you've seen it already so certainly it's a more fragmented world.
And then what we have when we talk cloud, but it is something we like where we position ourselves and I think youre going to continue to see us deploy capital to the bolt ons that Heath talked about.
In those spaces to really make sure we strengthen our position.
Okay. Thank you Chris we have the next question. Please.
We'll move next to Joseph Spak at RBC.
Thanks.
Just one quick clarification on your inventories which have been higher.
As planned as you've indicated but is that the new normal or do you think may go back down and if so.
And then just.
Some of the disruptions in the industry, we've seen some of the auto capacity shift.
Other parts of the world, particularly out of Ukraine, and others does that create any strain for TEP.
Well Joseph I first of all thanks for the question no our inventory levels are a bit more inflated now then I would say that not not a new norm. Okay. So.
Our days on hand are higher than we would normally run.
So even at these volume levels, we're carrying a bit more than we than we would normally this was intentional and we've talked pretty openly about that as we work our way through the year in this volatile environment, where we're seeing pretty aggressive swings largely higher in terms of demand.
The ability to be able to respond quickly to our customers and make sure that the customers' needs are met.
Wade the pain of carrying more inventory. So we did do that now as certain parts of our business.
Have we been able to get a little bit better insight into a few things in order patterns and so forth.
We will begin to start working down modestly this level through the rest of the fiscal year.
And youll see that corresponding impact on our cash flows but this is not the new norm and we will continue to talk about where we should settle in.
Particularly from a days on hand perspective.
From from that side of it.
In terms of the shift of production.
You are talking about we don't do any production in the Ukraine, but certainly some of our customers do particularly on the automotive side and as some of those customers have had to shift some of their capacity to other places and we're really talking about the harness makers within automotive.
That has shifted around it hasnt really impacted our inventory so much because.
It's already been sold to them, but as they shifted around which generally being shifted around within region. So in that case within EMEA.
To other parts of either eastern Europe , Morocco, or otherwise, so we're able to respond to those new locations and doesn't that doesn't specifically have a major working capital headwind towards us. So I hope I answered that question.
Okay. Thank you Joe we have the next question please.
We will go next.
Yes.
Yes. Good morning, Thanks for taking the question wanted to ask a bigger picture questions. We get deep in the call here, specifically, hoping to get a few <unk>.
<unk> for the ascent of your data and devices franchise over the past couple of years. This is roughly a $1 billion business in fiscal 19 pre COVID-19 . That's now pushing 1 billion and a half on the TM basis, obviously underlying market is growing here, but what are really the heart of my question is to what extent has the overall positioning of the company changed.
<unk> over that timeframe, especially as it relates to impacts on future growth and profitability.
You know on it it is something that I would tell you. It goes back to some of the hard work we had to do in the D&A business that we've talked to you about and it was around we wanted to be focused on highest ultimate high speed certainly we bring the innovation to it.
We have pretty even share across all the cloud providers and on top of it one thing that the cloud providers look for is also not only around technology and speed to ramp and I think our teams have done an exceptional job on how they keep up with the pace set of cloud customer wants and that's also created share opportunities on top of the <unk>.
<unk>.
Let's face it.
<unk> time, we had calls about the a D where we would talk about the problems we had in DMD and I really think the D&B story is one where we got focused we repositioned the cost structure, we refocused the team and the team has really executed very strongly on what has been a really good growth trend we've gained share.
There and we're also being a partner that you continue to see our confidence on these calls about the content, it's growing and I think there's still a lot of opportunity, especially while you get very customizable solutions that the cloud providers are getting around how do they get their operating costs down it's not just a capex decision.
It is an operating cost decision and the innovation that we get to work with the cloud providers was to make that happen is just is unique is when we deal with the EV and the auto Oems.
So there is a position we really what we built there we continue to be focused on it and it's going to continue to drive growth and cloud growth. It is projected to continue so I appreciate the discussion.
Thank you Lou can we have the next question. Please.
Go to Nik Todorov with Longbow Research.
Okay, Thanks, and good morning.
On cloud and data center Darren So I think this is the first time, you kind of highlight AI architecture impact on Ts and can you. Please talk about the.
The content uplift there and the architecture versus more traditional server architecture that <unk> benefits from.
What you have is you obviously have much more complicated compute as you get through there. So you get speed you also get increased thermal dimensions and that comes into things that our team that really works well with and they have to help our customers solve all of that and some of the orders we saw in the first quarter, where some new AI platforms.
It came in and are going to continue to benefit growth on each application. The content does vary it's not cookie cutter because the solutions that are cloud providers have are very customized around their chipsets. So it is something we will try to get you a little bit more as we do some of our investor days to give you a little.
More framing, but it is very different by the cloud architecture that can go after.
Okay. Thank you Nick I want to thank everyone for joining us. This morning. If you have further questions. Please contact investor relations at GE.
And have a nice morning.
Okay.
Ladies and gentlemen, todays conference call will be available for replay beginning at 11 30, a M. Eastern time today April 27 on this investor relations portion of Te connectivity website that.
That will conclude the conference for today.
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