Q3 2022 TE Connectivity Ltd Earnings Call
Ladies and gentlemen, thank for standing by and welcome to the T connectivity third quarter 2022 earnings call. At this time all lines are in a listen only mode. Later, we will conduct a question and answer session.
I would like to ask a question. During this time did you press star followed by the number one on your telephone keypad.
If you would like to withdraw your question. 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 Who's You'll Shah. Please go ahead.
Good morning, and thank you for joining our conference call to discuss G connectivity third quarter 'twenty two 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 <unk> Dot com.
This is a large number of participants on the Q&A portion of today's call. We're asking everyone to limit themselves to one question, we're 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.
Thank you Sunil and I also want to thank everyone for joining us today to cover our results for the third quarter, along with our outlook for the fourth quarter of fiscal 2022.
You know as I normally do on the four Heath and I get into the details on the slide I wanted to take a moment to discuss our performance within the backdrop of the current environment.
We delivered strong performance again in the third quarter with record sales and this represents 11% organic growth year over year.
We had growth in each of our three segments and organic growth across all lines of our business units.
Adjusted operating margins were in the mid 18% range and this is at level similar to where we've been running through the year, despite incremental headwinds that we've been experiencing.
And we also delivered record adjusted earnings per share that was above our guidance.
I feel our performance as a result of how we strategically positioned our portfolio around secular growth trends as well as the execution of our teams both from a manufacturing perspective and in our ability to effectively manage pricing in this inflationary environment.
I'm also proud of our teams as they continue to overcome broader macro challenges to effectively serve our customers and delivered the strong financial results, we're going to talk about today.
Now let me provide some color on the supply environment key end demand trends and the developments since our call 90 days ago.
When we provided our guidance last quarter.
We told you about it than anticipated impact from the sales.
Our sales to the Covid lockdown in China.
And even though as these lockdowns extended further into the third quarter than our original expectation our teams were able to recover and the sales impact for the quarter was negligible.
When you think about the global supply chain challenges and specifically around material availability I would tell you. They are about the same as they were 90 days ago.
And inflationary pressures continue to linger.
One element that I want to highlight that has changed since the last time. We spoke is the strengthening of the U S. Dollar.
This strengthening has significantly increased the headwinds we are facing from foreign currency exchange rates, both year over year and sequentially and Heath will talk about that a little bit more later.
Turning to the markets customer.
Customer demand remained strong as evidenced by our order levels and our strong backlog position and just to highlight our backlog has grown over 20% versus the prior year.
And we are seeing some consumer facing markets like appliance moderate, but we continue to see broad strength across our industrial segment and we still have a number of markets that we serve that are not yet back to pre COVID-19 levels and this includes automotive commercial air.
As well as medical devices.
And we expect growth in these businesses as supply constraints are alleviated.
And those markets continue to recover.
The other thing that I want to highlight we've consistently talked about and it has not changed.
It's the benefit we continue to see from the secular trends in our markets.
And the outperformance that we're generating from content growth and share gains.
We are benefiting from our position is and position as an industrial technology leader with growth from electric vehicles, Smart factory applications, including automation renewable energy and high speed cloud and artificial intelligence applications.
The other thing that I want to highlight that as we continue to navigate through this noisy macro environment is that we remain committed to our business model and long term value creation by driving further growth.
<unk> expansion and strong cash generation.
So with that as a backdrop, let me get into the slides and discuss additional highlights that are on slide three.
Our quarter three sales were a record at $4 1 billion.
And this was up 7% on a reported basis and up 11% organically.
As I mentioned, we saw growth across each of our segments and organic growth across all of our businesses once again, demonstrating the strength and positioning of the portfolio.
We generated double digit organic growth in the industrial and communications segments, and 8% organic growth in transportation. Despite on auto production environment that was essentially flat year over year.
Our orders were $4 2 billion in the quarter with a book to Bill of one point or two.
And this shows that the demand environment continues to be strong and I'll get into more details about order trends by segment when I get to the next slide.
Okay.
From an earnings perspective, our adjusted earnings per share was a record at $1 86.
That's up 4% year over year with adjusted operating margins of 18, 6%.
From a cash flow generation, our year to date free cash flow was approximately $1 billion with approximately $1 6 billion returned to shareholders. This year.
And I will tell you we've been aggressive with share buybacks as we've taken advantage of the recent market price dislocations with our stock.
As we look forward, we are expecting quarter for sales to be approximately $4 2 billion in.
And adjusted earnings per share to be around $1 85.
Our guidance reflects the benefits of an extra week that we have in the fourth quarter, but also factors in the impact of an increased headwind from currency exchange rates and if you look at the slide we provided the details of each of these items and how they impact our fourth quarter.
Okay.
Before I get into orders one thing I do want to do is move away from the financials for a moment and highlight that I am pleased that we issued our 12 corporate responsibility report last quarter, which reinforces our one connected world strategy.
When you look at the reported has many highlights but one of the key that I think is important was that we were successful in driving a 30% reduction in absolute greenhouse gas emissions in a single year and fiscal 2021.
And this was a very large step towards our goal of achieving a 40% plus absolute reduction in our scope, one and scope two greenhouse gas emissions by 2030.
Okay.
So with those being the highlights on slide three let me turn to slide four and I'll discuss order trends as well as what we're seeing in our markets.
For the third quarter orders were $4 $2 billion as we expected and this reflects the continued strong demand environment from our customers as well as we continue to see the impact from ongoing supply chain volatility in the markets.
Our backlog is up over 20% and increased double digits in each of our segments versus the prior year.
It is also important to note that the currency exchange headwinds are nominally impacting our sales, but also when you look in the year on year compares negatively impacts the value of our orders in the third quarter.
And this impact when you look at the year on year compare orders would be $230 million higher this quarter. If it wasn't for the strengthening of the U S dollar.
Okay.
In transportation.
We had a book to bill of one in the third quarter, which is in line with where the segment has run historically.
And keep in mind that we also have a strong backlog position.
And demand for autos remains healthy and is significantly higher than what Oems concurrently produce providing a potential setup for future auto production increases as supply chain bottlenecks begin to resolve and dealer inventories get back to more normal levels.
Yeah.
In our industrial segment, we saw another quarter of strong orders with a book to Bill of 116 and growth across all businesses year over year.
We continue to see a favorable backdrop and capital expenditures for factory automation manufacturing capacity.
And renewable energy and these trends benefit both our industrial equipment and our energy businesses.
The other thing about our industrial segment orders are we're continuing to see improving order trends in the commercial aerospace as well as Mark medical markets, where we expect growth as those markets continue to recover.
In our communications segment orders reflect a double digit increase in our backlog versus the prior year, along with expected moderation in the appliance market that we've been talking about all year and one thing when you look at the communications order trends. It is important to note that our backlog and our communications segment is <unk>.
<unk> 1 billion.
So with that as a backdrop on orders, let me get into the year over year segment results that you can see on slide five through seven.
And each one of those slides has the details for each segment.
So starting with transportation, our sales were up 8% organically year over year, our auto business grew 9% organically versus auto production that was roughly flat versus the prior year.
Global Auto production was 18 million units and this was slightly lower than our expectations due to the lockdowns in China.
And we do expect some sequential increase in auto production into the fourth quarter.
The trend around our content remain robust as we continue to benefit from increased electronic vacation as well as higher production of electric vehicles.
And we do expect electric vehicles to be up over 30% this year compared to a total auto production environment that is going to be flat.
As we look forward, we do expect continued expansion in our content per vehicle and Youll see that as we move from the first half to the second half of this year.
In the commercial transportation market, we saw 10% organic growth driven by North America, and Europe with significant market outperformance in all regions driven by strong content growth as well as share gains.
In our sensors business, we grew 2% organically and what was nice is that growth was driven by the focus we have on factory automation applications.
When you look at earnings for the segment adjusted operating margins were 17, 3%.
This was impacted by the inflationary pressures as.
As you know there is a time lag from when we incur higher inflation until price increases become effective with our auto customers.
Yes.
So let's move to the industrial segment and in our industrial segment sales increased 13% organically year over year.
Industrial equipment was up 19% organically with double digit growth in all regions and continued benefits from increased capital spending in factory automation.
In our energy business, we saw 17% organic growth driven by increased penetration in renewable applications.
And in our aerospace defense and Marine business. This was the first time, we've seen year over year growth since the market was impacted by Covid and we now expect continued growth as we go forward.
Our medical sales in the segment were up 1% organically with a modest increase in interventional procedures as well as medical device market is continuing to work through supply chain challenges.
From a segment margin perspective, our adjusted operating margins expanded year over year by 100 basis points to 16, 8% driven by higher volume and strong operational performance by our team.
We have made significant progress on our margin progression over the past several years and I am pleased with how the team continues to drive towards its business model target of consistent high teens operating margin.
So, let's turn to the communications segment and as you can just see looking at the slide our team continues to execute while capitalizing on the growth trends in the markets. They serve.
Sales growth was 16% organically year over year for the segment with growth in both businesses as highlighted on the slide.
Yes.
And our data and device business, we saw market outperformance driven by content growth in high speed cloud as well as share gains in artificial intelligence applications and as we highlighted last quarter.
Artificial intelligence applications do improve energy efficiency in the data center and it's just another example of how we enable lower carbon emissions with our customers through our engineering.
And our appliance business. It did perform ahead of our expectations. Despite the expected declines in the China market.
We saw growth both in North America, and Europe , and our clients' business and that is driven by continued share gains enabled by our global manufacturing strategy.
Okay.
From a margin perspective.
In the communications team continues to deliver outstanding performance.
The adjusted operating margins were 26, 2% and this was up 270 basis points versus a strong quarter in the prior year.
And our teams continued to deliver strong performance both on sales as well as proving margin resiliency.
Okay.
So with that as a backdrop of our segment results, let me turn it over to Heath, who will get into more details on the financials as well as our expectations going forward.
Thank you Terrence and good morning, everyone. Please turn to slide eight where I will provide more details on the Q3 financials.
Adjusted operating income was $761 million with an adjusted operating margin of 18, 6%.
GAAP operating income was $719 million and included $30 million of restructuring and other charges and $12 million of acquisition related charges.
We continue to expect restructuring charges of approximately $150 million for the full year as we continue to optimize our manufacturing footprint and improve the cost structure of the organization.
Adjusted EPS was $1 86, and GAAP EPS was $1 83 for the quarter and included a tax related benefit of <unk>.
And Additionally, we had the restructuring acquisition and other charges of approximately nine.
The adjusted effective tax rate in Q3 was approximately 19% for.
For the fourth quarter, we expect our adjusted effective tax rate to be roughly 20%.
So we continue to expect.
Adjusted effective tax rate around 19% for the full year.
Importantly, we continue to expect our cash tax rate to stay well below our adjusted ETR for the full year.
Now turn to slide nine.
Sales of $4 1 billion a company record were up 17% reported and up 11% on an organic basis year over year. When you think about our organic growth of approximately one third was driven by price increases and the remaining two thirds was driven by volume as a result of the strength of our portfolio.
In the third quarter currency exchange rates negatively impacted sales by $236 million.
And seven versus.
Versus the prior year.
As Terrence mentioned FX impacts have worsened significantly over the past 90 days and in Q4, we expect currency exchange rates to be a sequential headwind of approximately $70 million and a year over year headwind of approximately $275 million.
For the full year, we now expect a negative impact from FX of roughly $700 million, which is significantly worse than our view 90 days ago.
Adjusted EPS was a record at $1 86, adjusted operating margins were 18, 6% and I am pleased with the performance of our team given the incremental inflationary and supply chain pressures we are seeing.
We continue to pull pricing levers across the business to help partially offset these pressures and as we talked about last quarter. While we are not able to offset these cost dollar for dollar we continue to recover approximately two thirds.
Through price and the remaining through productivity initiatives, we continue taking pricing actions to offset these.
Inflationary pressures.
Turning to cash flow in the quarter cash from operations up from excuse me from operating.
Activities was 579 million free cash flow for the quarter was $423 million as we mentioned in past calls the year over year trend in free cash flow does reflect.
Strategic inventory builds however, we expect to work down inventory this quarter with Q4 expected to be the highest quarter of free cash flow for the fiscal year.
Through the first three quarters of the year. We have returned approximately $1 6 billion to shareholders with approximately $1 1 billion returned through share buybacks. We will continue to remain disciplined in our use of capital in near term, we have been aggressive in buying back our stock and taking advantage of investing in our own value creation opportunity.
Yes.
So we've made significant progress towards our business model over the past few years and our teams are continuing to execute well in a volatile environment. The strategic positioning of the portfolio has enabled us to deliver sales growth margin resiliency and EPS expansion. Despite the challenges. We are facing we will continue to focus on what we can control to effectively.
All of our customers and drive strong financial performance, including strong cash generation.
So now let's open it up for questions.
Thank you can you please give the instructions for the Q&A session.
Sure.
Paul.
In order to ask a question press star one on your telephone keypad.
As I have time for all questions participants is limited to one question. If you would like to ask a follow up question. Please press star one to return to the queue.
Our first question comes from Chris Snyder with UBS. Your line is open.
Thank you I wanted to ask about expectations for global auto production over the next couple of quarters, obviously, a big debate in the market consumers are pressured, but we've already had production near trough levels.
For the last two years. So I guess, what are you hearing from customers around expectations for production and in turn connectors over the visible time horizon and would also be interested in any views on auto demand versus production debate. Thank you.
Sure Chris Thanks for the question then.
No.
Let's just frame it a little bit auto production I talked about it in my comments.
We think in our fiscal year. The September year, there can be 76 million vehicles made this year.
And that's the same amount as it was made last year and you look at demand. We would tell you we think demand well above 80 million units.
And also to give you another guidepost back in 19 pre Covid. There was 88 million cars made on the planet.
So we still have a way to go to get back to pre Covid production.
And we can also see where inventory levels are.
Much every region of the world.
Still very low so we do think there is a potential for production increases even if demand comes down a little bit there is still a big disconnect between demand levels versus what our customers can deliver in a lot of that is well documented from the Oems around semiconductor supply and things like that.
I think the other thing that I just want to say is we did see 18 million units made this quarter.
And the next quarter, we do think and I said in my <unk>.
Prepared remarks, 19 million units and so there is I think upward momentum to production as we move into next year, if the supply chain continues to improve.
I think to his point, though.
And the other thing is what we control we control content, we don't control production certainly does not make semiconductors.
But I think the other element I just want to stress is and I think it's shown up through this period, even in a tough production environment like we've been in the past couple of years, how our content has expanded from what was in the sixties consistently in the eighties Youll see an increase in the second half really shows where we position the portfolio both <unk>.
As electric vehicles continued to be built continued.
Continue being a bigger pie, but also from the electronic vacation and as I told you on other calls when you look at that 20 plus dollar Delta.
Per vehicle about 60% of that is driven by electric vehicle growth.
Other 40 percentage due to electronics on both combustion engines as well as on electric vehicles. So I do think while production has been.
Frustrating.
I do think we're still well below demand and if we do get some breaks on semiconductor and other supply chain there could be upside.
As we go next year, even with <unk>.
Cloudy macro environment.
Okay. Thank you Chris next question please.
Your next question comes from David Kelley with Jefferies. Your line is open.
Yeah.
Hey, good morning, Terrence and Heath and thanks for taking my question maybe to follow up on the order summary page and specifically in the transportation and communications orders, which pulled back a bit here.
Can you talk about demand trends.
Transportation kind of outside of automotive.
Then also what Youre seeing in communications and maybe also if you could give us a sense of how orders are tracking.
For both end markets.
Q4 to date that would be great. Thank you.
Sure. So let me let me take the.
The first the last piece of your question first so when you look at our orders in July a total <unk> level.
They are running very similar to what they were running at last quarter. So.
Our orders overall have been pretty steady here, what we saw last quarter as we go into this one month and so from a July .
Remained healthy and the other thing that I think is important is we do have to keep in perspective, and we talked about this a lot over the past year two years.
A lot of customers are ordering ahead, certainly we have an elevated backlog position and even in some of the compares like our communications segment last year in this quarter orders were over $800 million.
So it's very strong compares and tough compares.
What we continue to look at in our orders as orders with backlog.
And I mentioned on the call and communications, we have $1 billion of backlog.
And our communication customers did a good job of ordering out I do think they did a better job than our transportation customers. When they were trying to make sure they were securing supply.
Overall, thats, what youre seeing in the trend so as we look forward and no different with our guide we continue to see healthy demand trends certainly the industrial markets continue to look like they are accelerating and we have two of our four markets in industrial.
We're a little bit later to the recovery party with medical and commercial aerospace industrial.
All equipment stays strong and the one market that we do see moderation in which isn't a surprise and we've talked about has been the appliance market.
We would've thought there'd be moderation, even before now.
We saw it in China, certainly that's tied to housing and property and we would expect that we will continue to moderate but when we say moderation you're really talking about our orders sequentially going from our March quarter to our June quarter being down like 12% I don't want it to be their fallen off a cliff, but they did moderate.
And certainly the backlog also supports where we guided.
So hopefully that gives you a better color about how we think about and also confidence.
Thank you David next question please.
Yes.
Next question comes from Thomas.
Thank you Mohan with Bank of America. Your line is open.
Hi, yes. Thank you Terrence can you talk about the various moving pieces in margins across the segments automotive was weaker and I know you experienced a lot of headwinds in the quarter.
Comms and industrial look quite strong how should we think about the trajectory from here and also if you could address.
How the incremental margin should track because that seemed to decelerate somewhat in the quarter. Thank you.
Hey, <unk> this is heath and I appreciate the question.
Listen I think.
If we just start with where we are <unk> in total right. We're still tracking in the mid 18% level, which is really where we've been tracking most of the year.
And there's no doubt.
Some of the strength coming out of our communications segment and then.
Some of the improvement we're seeing in industrial has helped offset some of the debt.
The pricing lag that we get it in the automotive and overall transportation business, but we're pretty pleased with.
The diversity of the portfolio and the ability to be able to.
Withstand these volatile environments.
Part of the answer to your question, though is the timing on when price increases go into effect.
Within transportation, specifically youre dealing with a lot of automotive customers and.
There is a lag between when we see the price increases go in relative to when we see the.
The impact of inflation and I think it's important for four for a solid remember that where we operate in the world inflation looks very different and in some cases it is worsens, including in Europe , where energy prices have continued to be a pretty significant headwind. So we are offsetting about two thirds of that inflationary pressure with <unk>.
<unk>, which as you know well as moving into positive prices was a big move.
Coming out of Covid here, but it does still be up because we can only cover about two thirds of it still does require us to make up the difference through either in our productivity initiatives and then obviously, what we've been undertaking with some of the longer term restructuring activities within the quarter I think it would be fair to say.
<unk> also felt a little bit of the impact from China, just the inefficiencies of not shipping much for two months and then catching it all up in the final months of the quarter that did have an impact as we move forward I think we will continue to focus in on where we stand.
From our ability to be able to pass on price, but overall, we're feeling we're feeling good.
Where we stand so.
With that.
That answers your questions. Thanks.
Thank you <unk> next question please.
Our next question comes from Mark Delaney with Goldman Sachs. Your line is open.
Yes, hi, good morning, and thank you for taking the question asked me to better understand the FX impacts and from a couple of dimensions.
So first you spoke to some of the translational impacts but are you seeing any change in actual business conditions and are any of the international companies potentially be more aggressive with our quoting activity given some of the changes in currencies and then specifically to the P&L I was hoping you could maybe speak a little bit.
More specifically to the four Q sequential EPS I.
I think you said $70 million on revenue quarter on quarter or could you speak to the EPS impact.
Sure Mark this is heath.
As I said on the call.
We sit here 90 days ago, I gave a number or a range for the full year FX impact I think I said between four and $500 million.
And that has stepped up by a couple of $250 million for our full year now to about $700 million and and.
About 75% of that has been in the second half of <unk> of our fiscal year that we're in the middle of right now.
No.
It does flow through when we give the.
The translational impact.
The overall EPS impact from all of that is about 17.
For the full year FY.
22, so it is it is meaningful to us.
In the fourth quarter, we expect that number to be year over year about $275 million. So incrementally worse than what we saw in the third quarter and as we look into the first and we look into FY 'twenty. Three obviously, we will provide more guide.
Here next quarter, but if we just snapped a line in the sand right now with where various currencies are it would be about a $300 million headwind in FY 'twenty three for us most of which would be in the first half of our fiscal year. So.
There are some numbers out at you just to try to frame up what we're seeing out there now your question on the competitive landscape is we really haven't seen a whole lot difference.
And that yes, we're keeping an eye on it but for the most part we haven't seen any anything changed considerably in terms of how.
Competitors are treating each other or along those lines.
And listen we're not economists, we're not going to predict where the where the dollar is going to go relative to these other currencies that we do transact in but we feel pretty good about our balanced position globally.
Okay. Thank you Mark we have the next question. Please.
Our next question comes from Joe Giordano with Cowen <unk> Company. Your line is open.
Hey, Good morning. This is Robert Jameson in for Joe just wanted to pivot quickly and ask you about the <unk>.
Buyback activity. It looks like you guys are running about <unk>.
Last year at this.
This time I was wondering if there's any changes to your capital allocation strategy.
Rob This is Heath I'll take this question.
Yeah.
Long term our strategy is unchanged right. So you think about it over a cycle, we still think about.
Two thirds of our free cash flow being returned to shareholders in the form of buyback and dividends and about one third being used for M&A. However.
However, there is we've always we've always.
Qualified debt with there'll be times, when we might deploy more into M&A and there'll be times, when we might deploy more through buybacks and that kind of takes into consideration market dynamics, where we're trading value of acquisitions out there relative to our value and Wayne everything through it through a.
<unk> blends as well so we have the good fortune that we have a very strong balance sheet and that has allowed us to play offense in the near term here. It's allowed us to play offense in the sense that we were able to make some strategic inventory builds and flex our working capital to make sure we're taking care of our customers.
That's that's not letting ourselves off the hook, we will start working that back down now.
Now that we're seeing a little bit.
In certain markets.
A little bit more visibility allows us to plan in our factories.
But we.
We've been able to flex with that we've been able to flex obviously using our free cash flow.
For buybacks as well, but I would not consider this.
A permanent change.
A more of an opportunity too.
Create value for our shareholders.
Okay. Thank you Rob can we have next question. Please.
Yes.
Your next question comes from Amit <unk> with Evercore. Your line is open.
Yes.
Good morning, everyone. So I guess I would classify the clarification.
The question is do you think.
Beyond the September quarter, I think there is a lot of concern around what <unk> would look like given all the macro worries that are out there.
Can you just maybe talk about the cross currents that you see FTE as it relates to <unk>.
The segments would be helpful. I think to just level set things like content growth and how you see that stacking up next year and then if you could just clarify I heard your discussion on margins.
Maybe I don't appreciate there's enough yet why are margins going down in September quarter sequentially. When I think some of these headwinds you talked about sits up their lithium so maybe just help with the margin puts and takes involved with September . Thank you.
Thanks for me and let me get into the first half of your question then.
As you know we've been guiding a quarter out so anything we will give you more about next year, but I'll give you. Some initial thoughts here and then we'll tighten them up in 90 days.
The transportation back to an earlier question I add content feel very good about and you can all see the OEM programs that are coming out on electric vehicles.
It isn't one or two Oems in the world. It's every OEM in the world that's coming out with electric vehicles that the content momentum that we've had we continue to see that and probably being closer to the higher end of the range that we've talked about in the four to six.
But that's not only in automotive that's also in commercial transportation and our commercial transportation teams and driving a lot of content. So I think you can have a good content, there and let's face. It this year in commercial transportation and 'twenty to China was rough China drove the entire global market to contract this year.
But our team and I do think as you think about some of the stimulus China is doing around.
Infrastructure as well as what they're doing around auto stimulus as they're coming out of Covid I do think there is upside opportunity versus the production environment in both of those markets that I said earlier.
And certainly that China's stimulus is important because it's one of the most of them, it's a bigger market than the U S as well as Europe .
In industrial I would tell you.
We feel good about the capex trends feel very good about the renewable positioning we've done in energy and you saw our 17% growth here this quarter and energy I think youre going to continue to see that momentum because they're tied to good trends.
And then comm air and medical I know I spoke about they are growing again.
<unk>, we're still only at two thirds of what we were pre COVID-19 and while single aisle has improved there's double aisle opportunity that's even more.
Content for us on a single aisle aircraft.
So the content through there and it's really about how does the large air framers continue to ramp production.
Get them there.
When you look at our communication segment, I think it's going to be probably a tale of two cities. The appliance market. We talk to you about we expect that to moderate next year, but offsetting that will be cloud capex on the question.
Where does cloud Capex go after it was up 20%. This year, we do expect cloud Capex growth next year, we just have to see where our customers really put it at not sure it'll be at 20%, but I still believe it'll be growth. So there is a bunch of moving pieces out there, but I would tell you when we look at the order trends we all.
Also look at the content growth that you've seen in our results plus the backdrop of where we play it still feels very constructive as we go into 'twenty three and as I said when we get on our next quarter call we'll add.
More color versus what we're seeing so heath why don't you take the second piece of question I'm sure Amit.
Your question was relative to implied margins for Q4.
As you know we did not guide a margin number.
So if you're backing into a margin number relative to the sales and the EPS I think.
One taking consideration the tax rate's going to be a point higher as we guided in the fourth quarter. So we're not seeing a dramatic fall off in margins.
But if youre on the fringes if you will keep in mind, a couple of things as we signaled we do expect.
Our communications segment to be a little bit lower revenue levels in the fourth quarter, just because of some of the appliance pieces. The tariffs just talked about that has a little bit of a mix impact. There is no no no change in our assumptions around this inflation and price.
Go get when we're only covering two thirds and then.
Again on the fringes youre going to be working down some inventory in the quarter and that's going to have a little bit of impact as we work through that cap, but.
It's not something that we see falling falling.
Materially at all if any.
Okay. Thank you Amit could we have next question. Please.
Your next question comes from Atlanta.
Securities Your line is open.
Great. Thanks for taking my question.
If we zoom out and don't really focus on any particular end market or segment just look at the overall revenue performance and overall bookings.
Sort of feels like the elusive soft landing, we're still seeing good revenue growth but.
But the orders are backing off these very elevated levels that we've experienced in <unk>.
Quarters is that the way you all see it and.
If that's the right characterization.
How many more quarters of this sort of performance do you anticipate do you think that.
This is going to continue to play out and we'll continue to see perhaps a moderation of orders but.
Sort of a burning of the backlog and revenue growth still sort of at.
At good levels.
Well thanks for the question and I guess I know, we spoke to many of you about it.
Yes, when we think about our business and the lead time for our product, let's put things into perspective about our lead times.
For an average product you might be six to 12 weeks.
I do want to frame when you look at <unk> and you think about an average lead time.
6% to 12 weeks.
Not some of the lead times you hear from other product categories that you have.
So there's an element here of when we were talking to you about book to bills of one two.
We always said there will come a time that as markets become more normalized we would expect our book to bill to reflect more normal patterns than a one two book to bill So.
When I look at it and I think about transportation.
Getting closer to a one we expected to get to certainly as we work off backlog like you saw in communications, we got a lot of backlog, we have over $1 billion backlog in communications.
Customers they feel good with that backlog they are not going to place more orders are going to want to work that off and we look for pushes and cancellations are people pushing out orders are they cancelling orders, we are not seeing any major trends and pushes and cancellations.
So with the indicators that we're looking at.
So that hey, while we have some markets in transition like appliance that we've been highlighting to you. We also still have markets that are still trying to catch up like commercial aerospace. So I do think it's an environment, where not everything is going up too.
And growing and we just have to realize.
If a customer is concerned about the macro they are probably going to get a little bit more conservative and say hey, let me work off a little bit of backlog. So I think youre going to continue to see book to bills, but getting more normalized in an environment like we have.
But certainly we have some markets where customers are concerned about supply chain volatility and like we've talked about in the industrial segment. We're still at a 116 book to Bill, which is a very strong book to Bill and that means we're still building backlog.
Okay. Thank you will can we have next question. Please.
Your next question comes from Amit <unk> with J P. Morgan Your line is open.
Hi, This is <unk> on for semiconductor <unk> from Jpmorgan. Thank you for taking my question.
Just wanted to ask regarding the order trends in Brazil of Youre seeing some of your peers.
Downgrading the expectations with the growth in this particular sector traditionally the global PMI is that'll slow down relatively compared to the starting of the year.
What exactly is driving strong verticals for you in this particular sector and as you said.
Youll see them accelerating.
When I when I look at our thank you for the question when we look at our industrial business unit. It also comes into the backlog of our customers and if you look at our customers that a role the robot manufacturers of the world certainly the factory automation and you even go back to.
Semi capacity we put in.
Electric vehicle battery capacity being put in other automation program being put in there the drivers of it.
So you have to look at the capital spending and the backlog of the projects continues to be very strong and that's creating backlog for our customers of the world whether they are in Asia, whether they're in Europe , whether they are here and whats nice is were very globally deployed in that business unit and orders continue to be very strong as people are <unk>.
And to make sure they can fulfill their backlog and we've really positioned well in that space and you've seen that outperformance consistently over the past year and a half.
Okay. Thank you can we have next question. Please.
Your next question comes from Matt Sheerin with Stifel. Your line is open.
Yes.
Good morning, everyone.
Thanks.
Get your take on inventory picture at your customers.
Obviously.
With longer lead times there is.
Ordering and perhaps double ordering even of your products, which we don't typically see.
With Interconnects, but are you getting a sense of any build particularly in the industrial markets, where you have a lot of distribution exposure, we're seeing lots of inventory yet matched in the Oems and at some point.
Im going to give and we're going to see a correction.
Wondering are you seeing that or are you expecting that at some point.
Well I think the thing is <unk>.
First off being you know people have been trying to make sure youre not going to.
One a hold up manufacturing of an end product for a connector if youre waiting for semiconductor people will want to make sure. They have the interconnects with certainly the semiconductor b in the brain and we're a little bit more like the arms and the legs.
But when you look at it and you take distribution to what you've said distribution.
Distribution inventory is still not back to where we would expect that debate is still probably 15 days light on a term perspective.
Where it was pre COVID-19. So we continue to monitor that inventory position.
And that's an important thing to watch to make sure that the distribution channel does not get heavy from a days perspective.
So feel good that they're still in a good spot.
When you get into where our product goes everywhere in the world.
We're not going to know every little pocket of inventory.
But it's something that if lead times continue to get better and I would tell you they have gotten better yet they are stable, but they're not better.
You would expect there might be a little bit of an air pocket, but we're not at that point yet.
Okay. Thank you Matt can we have the next question. Please.
Your next question comes from Christopher Glynn with Oppenheimer. Your line is open.
Thanks, Good morning, Terrence Pizza dough.
Hey, good morning, I had a quick.
I had a question about how you're viewing.
Market share in the electric vehicle space, just curious if you're able to.
Si or see share gain there the market is still too formative.
Now when you look at that and I think you have to start with we have a very strong position already.
And as we say we are in essentially every car in the plan it already.
So I think our market share our strong position, we already have that it has been in combustion engine as we bring the technology and I know we've shared content elements of how you look at an electric vehicle, it's about <unk>, what we have.
But then you also carryover what we do on a low voltage architecture.
That when you add the high voltage motors in it.
Basically as additive so when you look at it from a market share I feel very good about the programs. We're winning whats great is it has global as our current position we want to sit there and make sure we're globally position.
And it's pretty similar to what we have and what we had in our historical market share.
Okay. Thank you Chris can we have the next question. Please.
Your next question comes from curious Michelle with Wolfe Research. Your line is open.
Great.
Okay. Thanks, so much.
Yes.
Understand how do you think about the interplay between order activity and backlogs.
For example, if youre seeing some segments like transportation now in a more normal book to Bill.
But you also mentioned that the backlog is still growing in those.
Is the right way to think about that potentially the order activity.
Would moderate as those customers trying to work down.
Backlog.
I'm just trying to understand how we should be interpreting those going forward.
Now when you look at book to Bill of one basically means youre not building backlog. So I think the one thing when we look at book to Bills. Please remember theres two two numbers in our book to Bill equation. The order number and then obviously the revenue number and you have to realize we have brought up our output.
By the growth that we talked about so the bill has also gone up.
But when you look at it similar to what we talked about in communications. If the backlog is so strong you can have a book to bill below one because the customers feel they are scheduled out over a couple of quarters could be up to three quarters in our case, where they say, hey guess, what I feel good where I'm primed and assist.
And you could run below one a little bit.
So theyre just key factors of how it works and I think you have to keeping the mindset I'll go back to what I said today. When we have an average lead time of six to 12 weeks, let's say.
We arent somebody that has backlog that goes out years that is not our business. Our backlog typically is within the next yes.
Nine months.
Okay. Thank you <unk> can we have next question. Please.
Your next question comes from Jim Suva with Citigroup. Your line is open.
Thank you I know, it's just kind of an accounting thing with the extra week, but I know that there is also year end things whether it be stock while seeing more increases but also in your fiscal Q4, a lot of the Oems.
Production change over the years and kind of close for annual vacation in Switzerland model years and such.
I know you gave some commentary in your slides on the Q4 impact I'm just wondering is it more.
More complicated than just adding one extra week of sales and EPS guidance.
The things I'd mentioned and importantly, though for setting up expectations for Q1, I know, it's early but do we just removed that exact same amount in Q1 or is it kind of a non linear.
I expect that it's a lot more.
Complicated than what people just may initially think but I think it's important so we have a level set and don't get ahead of themselves or extrapolating that going forward. So any additional clarity around that on revenues and EPS would be great. Thanks.
Thanks, Jim and good to hear from me I'll, let heath handle that.
Thanks Terence.
Jim.
I'm sure you remember that we went through this in the fall of 2016 as well right, which is the last time, we had the extra week and so this is a convention that does happen every five to six years based on.
When we the true up of our of our fiscal calendar.
Where we ended up with that extra week. So if you think about it from that from a fiscal year perspective operationally nothing changes right. So there's nothing changes relative to a cut over into our off to our October what should be the first month of FY 'twenty three nothing.
Changes with employee schedules and everything else it really is.
Basically a mechanism that trues up the calendar every five years to six years.
It does provide as we did here we gave our best guesstimate of what that extra week will provide which is about $250 million in revenue and about 10 cents of EPS, what will happen and when we detail of our fourth quarter results and our Q1 guide here in about 90 days.
We will tighten up that estimate so we'll give you what it what we calculated.
Appropriately or more accurately at that time, and then obviously as we move into the first quarter first quarter will be back to having 13 weeks.
And we will move forward with that way so from a Q4 to Q1 compare there is an extra week in Q4 versus Q1, we're estimating that to be about $250 million in about 10 cents of EPS.
<unk> tightened all that up and be very transparent.
As we as we close the books here at about in about 90 days. So I hope that answers your question, but.
It's some fund stuff we work through every five years to six years with us with this.
Fiscal calendar.
Alright. Thank you Jim can we have next question. Please.
Your next question comes from Steven Fox with Fox Advisors. Your line is open.
Thanks, Good morning, Hey.
I heard all the comments on margins. This morning, I was just wondering if you could dig a little deeper into the communications margins I think.
You keep telling us not to expect these mid 'twenty margins to repeat themselves, but they keep repeating so there must be something going on in terms of products or pricing or execution since you've put up 26% and youre talking about pressure on appliance market. So any color there would be helpful. Thanks.
Thanks, Steven this is heath.
Listen.
I know.
The question.
And our stated business model right. We've said this segment.
Should be in the high teens operating margins.
I'm acutely aware that we have been running significantly higher than that particularly where the past couple of years I think what's important here is is to step back a little bit and say.
This was a journey in this segment to get it to where it is today right. There was a lot of if you go back several years, there was about $1 billion of consumer related.
Products that we walked away from and then there was a tremendous amount of restructured to get this business where it is today.
And what that shows is when you get that operating footprint right and then you get these levels of volume that we're seeing out of both appliances as well as data and devices. We can kick out these kinds of margins. So theres nothing artificial and these margins we have been aggressive on price as you would expect and in some cases, we are able to pass.
Through price.
In both industrial and in communications, a bit more efficiently because a bigger chunk of those businesses go through channel partners and those those those price increases can go into a little bit more rapidly than take effect more quickly versus transportation that is of renegotiation OEM by OEM. So there is some price piece.
There's no doubt about that.
And we will continue to keep our foot pressed down on those on those elements to help cover we're not we're just trying to cover where we stand from an inflationary pressure environment, but when we do see appliance moderate right. We've been running about $1 billion annual run rate in appliances, and if that moderates down.
Element <unk>.
Now we do.
Check that to have a little bit of pressure on the margin front that doesn't mean, we see a collapsing and we will give more color as we're more comfortable with that here is this fall.
Right now at these volume levels. This would be the margin you would you would expect.
Okay. Thank you Steve can we have the next question. Please.
The next question comes from Joseph Spak with RBC capital markets. Your line is open.
Thanks, So much can you give us some color on what your customers are thinking in Europe in light of the energy issues. There like Ironically, one of the things. We've heard is in transportation industrial some of those players may try to produce as much as possible. This quarter to get ahead of what they think might be potential larger issues.
Later in the winter.
As long as the supply chain allows them to do so are you seeing any evidence of that and then related I do think you have some facilities in Germany. So how directly impacted would you be buying gas shortages.
Yes, good question and I would say this is real time, and we're staying close with our customers. So I would not say there is one size fits all.
As they deal with it so the key element for us as we got to stay close to our customers on it we do have a team that's working it real time and this is a real time issue to say hey, if output of our customers were impacted and we do have some factories in Europe , primarily supporting the automotive industry.
We would have impacts as well so it's a real time situation.
And but I would not assume it's one size fits all across Europe .
Okay.
Thank you Joe we have the next question please.
Your next question comes from Luke junk with Baird. Your line is open.
Good morning Heath, just hoping you could help us unpack the margin in industrial this quarter. Its a new high watermark, we look bigger picture and there was a nice step up sequentially as well last time, we saw this kind of step up was in the third quarter last year and that margin upside proved to be pretty sticky on a go forward basis. So just hoping you could expand on what's <unk>.
Going on under the surface in that business this quarter, especially as it pertains to the path of industrial margins from here. Thank you.
Sure. Thanks Luke.
Listen we've been very public going back almost five years now on this march towards.
Margin improvement in this segment.
All but a lot of restructuring activity.
We talked about at the time this is going back when we started this journey of taking over 20 facilities offline and consolidating those into lower lower cost locations, where we already had capabilities and capacity and I would say, we're two thirds the way through that at this point.
Certainly we did not anticipate COVID-19 and some of the other and the bounce back and so forth.
That we've had to adjust the playbook a little bit on timing, but the overall strategy is unchanged in and a lot of it is around rooftop consolidations and so forth and we've been more aggressive in this segment with acquisitions, which also.
Give opportunity to us to further right size and realize synergies by integrating those into existing facilities that we already have so and most recently the <unk> acquisition came in and we see a real margin opportunity there within that business, which is in our industrial.
Real equipment.
Portion of the overall segment.
Having said all of that there are still pieces of the segment that are underperforming from a margin perspective, and navy and largely that's due to volume right Terrance talked about medical and our commercial air business, which is inside our aerospace and defense business unit.
They are far from getting back to normalized volume levels in both of those opportunities avail.
Opportunities for us to continue to see margin expansion. In addition to some of the restructuring activities. So hey.
We're pleased with the results this quarter.
In any one quarter there can be noise.
That swings your margins a point or so either direction, but we're pleased with the results. We're pleased with the trajectory.
Of where the cost structure is in this business.
Obviously as I mentioned in the previous question, we're able to get more pricing in this segment. This segment than we have in.
In transportation, so theres a lot of good things going here.
And with the recovery of medical and commercial air.
We feel like Theres still legs to go.
Okay. Thank you look we have the next question. Please.
Your next question comes from Nikolay Todorov with Longbow Research. Your line is open.
Yes, thanks, and good morning, Duke.
Two clarification questions from me one is in auto you posted 9% outgrowth versus production.
But I just wonder was there any inventory build in the June quarter last year that would suggest that your outgrowth was even stronger and then the second question a clarification I think it was asked but what is the FX EPS impact sequentially, I think I heard or.
Revenue impact $70 million to $75 million sequentially, but what is the FX the EPS impact sequentially. Thank you.
So one I'm going to let him take the second part and I'll talk about the first part, yes, Nikolay I apologize if we if we didnt provide that the sequential impact we're on FX, we are estimating to be it's about <unk>.
$70 million.
Revenue in about five cents of EPS sequentially.
And then on the outperformance.
Quarter on quarter, I'm always going to caution you be careful on trying to come up with inventory builds in the quarter, especially with the volatility we have so when you look at it.
I don't think there was a meaningful impact that you should take that outperformance and add or subtract.
Okay. Thank you Nick we have the next question. Please.
Your next question comes from William Stein with <unk> Securities. Your line is open.
Great. Thanks for getting me back in.
I apologize if this might have already been asked but specifically in the transportation end market you have a target of 20% EBIT.
EBIT margins and I.
I understand that right now we're going through this well.
Well documented and well discussed on this call.
Inflationary effects.
There is a timing effect of passing that on do you all have an expectation as to when you might approach that 20%.
Level again like something we should think of in the next year or two or is that now feeling longer out in time.
Okay.
Thanks for the question.
I'm not going to go back through like you said, we've discussed a lot of things on the call here relative to the current situation with the our ability to get price relatively inflationary pressures and the pressures if thats putting on the business.
So as that equation morphs over the next year. So we'll see how that plays out. The other thing was if you recall a couple of years ago, We did start, particularly in our western European footprint for transportation of taking.
Restructuring a couple of.
Locations and Thats well underway in some cases.
We will see we'll see.
Support coming out of those actions here as we get into <unk>.
Next year, but the other thing that we.
Remember as we've talked about in our business model right that 20% target for transportation that never contemplated.
Auto production being down in the 70 677 million units so.
If you start to we start to see some support there where we're getting.
Closer to 'twenty, one plus million units a quarter.
I think thats that is.
Better opportunity for us to capitalize on not just our content growth, but also absolute volume production that we're set up to support so I think that would have the bigger impact versus most of the other variables.
Okay. Thank you well I want to thank everybody for joining our call. Today. If you have further questions. Please contact investor relations at Te. Thank you.
And have a nice day.
Ladies and gentlemen, todays conference call will be available for replay beginning at 11 30, a M. Eastern time today July 27 on the Investor Relations portion of Te connectivity website.
That will conclude the conference for today.
Okay.
Yes.
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