泰科電子 (TEL) 2010 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the Tyco Electronics report strong fiscal second quarter results conference call. (Operator Instructions). I would now like to turn the conference over to your host, the Vice President, Investor Relations, Mr. John Roselli. Please go ahead.

Thanks, Rochelle, and good morning. Thank you for joining our conference call to discuss Tyco Electronics second quarter results for fiscal year 2010 and our outlook for the third quarter and full year. With me today is our Chief Executive Officer, Tom Lynch, and our Chief Financial Officer, Terrence Curtin.

During the course of this call, we will be providing certain forward looking information. We ask you to look at today's press release and read through the forward looking cautionary statements that we've included there. In addition, we will use certain non-GAAP measures in our discussion this morning and we ask to you read through the section of our press release and the accompanying slide presentation that addressed 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 web site at tycoelectronics.com. Also, as we announced this quarter we have renamed our undersea telecommunications business to TE Subsea Communications or Subcom for short. And you will hear us refer to it that way today. .

Now let me turn the call over to Tom for some opening

Thanks, John. Good morning, everyone. Let's start with slide 3. I guess the best opening would be what a difference a year makes -- but we really had an outstanding quarters in the second quarter.

Our sales were up 27% year-over-year and 2% sequentially. Our operating margin of 13.9% was up 240 basis points sequentially and well ahead our 12 of 12 goal. Our gross margin of 32.4% was the highest since 2007 when the company separated. Our earnings-per-share up $0.64 was up 36% sequentially and significantly exceeded our guidance. If you recall our guidance -- the mid point of our guidance was $0.52 and so we were over that by $0.12. $0.08 of that was operational. $0.04 was tax and Terrence will be walking you through that in detail. And our free cash flow was strong at $422 million and we're on track to deliver in excess of $1.2 billion of free cash flow for the year.

The performance was due to definitely improving economic environments, but strong execution on the company's part as well. The global economic environment continued to improve this quarter and we were able to capitalize on this trend. Our electronics components segment was up 55% year-over-year and 4% sequentially. This growth was broad-based across all geographic regions and end markets, and our CFO will walk you through each of the markets in detail in a few minutes. This more than offset the decline in our subsea communication segment and as you know we've been foreshadowing that expected decline for several quarters now.

We're really encouraged by the demand strength in most of our electronic components and end markets and expect sales to stay at the current level in the second half, with continued growth in the industrial markets offsets normal seasonal decline in automotive in the fourth quarter. And it's pretty clear that the environment is much better than three months ago and than we felt three months ago and significantly better than we expected when we sat here six months ago.

During the second quarter we did begin to see a pickup in business levels in our specialty products and network solutions segment, and as a result we expect revenue to increase about 10% in the second half in these segments. As you know, these segments turned down later and components when they're recovering about two quarters later. Again, this growth will more than offset the further softening in our subsea business, which is now going to settle in at about $150 million for quarter range.

I'm also really pleased with our continued improvement in execution. Our gross margin increased about 3 points sequentially to 32.4% and this drove the adjusted operating margin increase to 13.9%. Improving gross margin has clearly been a top priority for the company for several years. The reduction in our footprint coupled with our productivity programs are clearly delivering results. Our second quarter gross margin also benefited from about a point of favorable mix, about half of which was due to very strong margins in the subsea business and those strong margins in the subsea communications were directly related to excellent execution on the part of that team.

We expect gross margins to be in the 31% range for the balance of the year, which is approximately 2 points higher than our 2008 levels on about 20% lower revenues. Our operating margin has exceeded our near term goal of 12% and we're well on our way to our next key milestone goal of 15%. We thousand expect to achieve 15% margins at a sales level of around $14 billion. Finally, we had another good -- another very good quarter of free cash flow at $422 million in the quarter. We paid a quarterly dividend of $70 million and repurchased approximately 5.7 million shares during the quarter.

I also want to highlight our strategic progress in a couple of key areas as I typically do each quarter. In China, which is now the largest vehicle producing country in the world and they're on path to do 13 million to 14 million vehicles produced in China this year, automotive vehicle production was up 63% year-over-year in the second quarter. Our China automotive business grew almost 200% in the quarter and we're now on track to reach $0.5 billion of sales to this market this year. So our China automotive business fiscal year 10 our current year is going to be about $0.5 billion dollars. We continue to build on our very strong positions with both the multi-national OEM as well as the local Chinese OEM.

In our data com business, which is almost $1 billion dollars in annual sales, our new high speed data com product platforms continue to gain market accept and we have had several strategic wins in the US and Asia over the last three months. It's been a high priority business for us and I think in the last year our new platforms are really starting to catch on and increased design wins are coming as a result of that.

We also continued to improve our position in the mobile phone market with sales growth of 34% year-over-year. Over the past year we further strengthened our position with the leading handset makers and expanded our business across the high growth, high content smartphone segment of the market. So as we know this is a -- continues to be a growing market. Slowed down a bit last year. Smartphone portion of the market is really accelerating and there's significantly more content in smartphones for companies like ourselves. And we feel we're very well positioned to take advantage of this shift in the market and overall growth.

So now I will turn it over to Terrence who's going to cover our Q2 performance in more detail.

Thanks, Tom and good morning everyone.

I'm going to start by reviewing or sales performance by segment and market. Then I will get into earnings and cash flow.

So if you start with slide 4, this shows our overall revenue performance both by segment both on a year-over-year and on a sequential basis. Total company sales of just under $3 billion were up 27% year-over-year in the quarter. The growth was driven primarily by our Electronic Component segment which was up 55% with growth across all markets. Excluding our subsea com business, growth was broad based across all regions with Asia up 64%, Europe up 29%, and the Americas up just shy of 20%. We also benefited year-over-year from currency translation which had an impact of about 470 basis points on year-on-year growth, or roughly $100 million.

On a sequential basis our sales were up 2% with growth in the Electronic Components, Specialty Products and subsea communications segments which were partially offset by a slight decline in our network solution segment that was driven by typical seasonality. In our businesses serving the consumer markets, which is about half of our revenue, our sales increased 73% year-over-year and 2% sequentially. Remember that this quarter last year was the low point in the downtown in these consumer markets.

As expected, our industrial and infrastructure markets started to show improvement and our sales were up 3% versus the last quarter. Order rates in the industrial and infrastructure markets improved throughout the quarter, as evidenced by our three largest segments having book to bill ratios of 1.05 or greater. Our orders were up 6% in these markets on a sequential basis, and this momentum supports our outlook for the improvement in these markets for the remainder of this year.

Now lets me get into segment performance by market and when I talk growth rates all changes that I'll discuss will be on an organic basis.

So if we can turn to slide 5. On the left hand side ofthe slide let's look at the key markets in our component segment. In the automotive market, our sales versus the prior year increased 78% and sequentially were up 5% with growth in all regions. Sequentially, automotive production was flat at approximately 17.5 million vehicles. However, as expected we did benefit from continued restocking in the supply chain. Based upon current projections quarter 3 auto production is expected to be slightly down to about 17 million vehicles. We expect that our sales in the automotive market will be similar to quarter 2 levels as the effects of restocking wind down and our sales get back in line with vehicle production. And as Tom indicated we do expect right now we will get normal seasonality beginning in the fourth quarter which typically is about a 5% decline going from quarter 3 to quarter 4.

In the data com market, which includes sales to the communication equipment, server and storage markets, our sales increased 8% year-over-year and were up 7% sequentially, driven by the rebounds that's occurring in the enterprise market we're spending on broad band infrastructure and data storage equipment has increased.

In the industrial equipment market, our sales were up 29% versus the prior year and up 18% sequentially and we're seeing improved end demand overall as capital spending increases. And China is leading the way of the demands upturn, and we did also benefit in this market from some distributor restocking.

In the appliance market our sales were up 56% versus the prior year and up 14% sequentially and we saw double digit increases across all regions. In the computer market our sales increased 19% versus the prior year and were up 4% sequentially, driven by end demands for notebook and netbook products and, finally, in the consumer device market which includes our sales to the mobile phone an consumer electronic markets, our sales were up 39% versus the prior year but sequentially were down 8%. And the sequential decline was driven by post holiday declines in the end market demand.

Let me talk about network solutions on the right hand side of the slide. Our sales in the segment declined 6% versus the prior year of 1% sequentially. Sales declines were driven by continued capital spending reductions by our customers and a seasonal decline in the energy market. As mentioned, these markets and segment are later cycle and in 2009 they began to decline approximately two quarters later than our consumer end markets and we're seeing a similar lag on the way back up. Order rates have improved in the segment and our book to bill ratio for the quarter was 1.05. On the submarkets in the segment, sales to the energy market were down 67% versus the prior year driven by continued lower spending and inventory reductions at the utility customers. Our revenues were down sequentially 5% due to the typical seasonality we get in this business in the winter months.

In the enterprise network markets our sales increased 8% versus the prior year and were flat sequentially, reflecting improvement in the data center, government and education markets while the commercial construction markets continue to be weak. Our sales to the service provider market declined 15% versus the prior year due to the slowdown in wire line capital investment in all regions. Revenues were, however, up 5% sequentially due to increasing fiber deployments in international markets, specifically Europe. We expect this uptake to continue as the increasing demands for data anytime and anywhere requires more capacity in both the wired and wireless markets. For our third quarter we expect total segment sales in the network solution segment to increase about 10% sequentially with growth in all of our markets. This will be our first year on year increase in this segment since before the downturn.

Now, let's move to slide 6 to talk about Specialty Products and subsea communications. On the left hand side starting with specialty, sales in the segment increased 4% overall versus the prior year and 6% sequentially. The book to bill was 1.08 in quarter 2 and for quarter 3 we expect a mid single digit increase in revenues overall. Sales to the aerospace, defense and marine market declined 8% versus the prior year but were up 8% sequentially, due to improvement that we're seeing in the commercial aerospace and business jet market. During the quarter we saw a nice increase in our orders and for quarter 3 we expect a low single digit increase in revenue sequentially.

In the touch systems business our sales were up 6% versus the prior year and up 5% sequentially. We're benefiting from our sales into the retail market as the capital spending in that area continues to improve during the quarter. For the quarter 3 we expect a double digit increase end markets revenues versus quarter 2 driven by improving conditions in both the industrial market and the improved capital retail spending trends I just mentioned. We're also seeing significant early interest in our newer touch platforms that we talked about last quarter and although we don't anticipate any revenue from these platforms until next year.

In our Circuit Protection business which serves mainly our consumer markets, sales increased 67% versus the prior year and sequentially revenues were down about 1% as expected due to the normal seasonal decline in sales to the consumer mobile device markets. And lastly in specialty in our medical products business versus the prior year but revenues were up 8% sequentially driven by improvement in disposable applications.

Looking at the right side of the chart and our subcom segment, as expected sales declined 33% versus the prior year. Sequentially revenues were up 4%. Our backlog ended the quarter at $616 million and we expect revenue of approximately $150 million to $175 million in each of quarter 3 and quarter 4 which would result in full year sales in the range of $700 million to $750 million which is down from $1.2 billion last year.

Bidding and quoting activity remain solid, although we accidents book any large products not quite. We did win a project for approximately $125 million that will be going into our backlog in quarter 3 and we have been awarded portions of two other products in excess of $100 million each that are in the process of obtaining funding. All of these projects will benefit 2011 and our initial view of 2011 sales for the subcom segment is in the range of $600 million to $700 million.

Now lets me discuss earnings with which start on slide 7.

Our GAAP operating income for the quarter was $398 million which includes restructuring and other charges of $12 million. In connection with our manufacturing simplification, we closed another 2 sites in the quarter and our current site total is 90. Our footprint simplification is on track and we expect to get down to a mid-80 site count by the end of 2011. We also continue to refine our cost estimates and timing of P&L charges an we expect approximately $30 million of charges in quarter 3 and for the full year we now expect charges of approximately $120 million. Currently for 2011, we expect approximately $100 million or less in charges. Overall we have made excellent progress in streamlining the footprint, and this has been a major contributor for margin improvement, as Tom mentioned.

Adjusted operating income was $410 million in the quarter with an adjusted operating margin of 13.9%. The falter on sequential sales and improvement in margin continues to demonstrate our improved operating leverage from our cost action at end of our ongoing productivity program. This was particularly evident in the Electronic Components segment where the adjusted margin was 13.6% compared to a loss last year.

In addition, total company margin did benefits from the completion of certain contracts in the subsea communication segment which possibly affected overall margins by approximately 50 basis of points in the quarter. In quarter 3 we expect our adjusted operating margins to continue to be above 13%. Adjusted EPS for the quarter was $0.64, up $0.36 from the first quarter, reflecting the growth in operating income and an approximately $0.04 benefit from a lower tax rate.

Now let's move to slide 8. Starting at the top half of this slide, our gross margin in the second quarter was 32% and this gross margin is the highest level since our separation in 2007 and is an increase of over 900 basis points versus the prior year and 300 basis points versus quarter 1. As I mentioned, one time items in the subcom segment benefited gross margin by approximately 50 basis points. In addition, gross margin also benefited from volume increases and a slightly favorable sales mix in our component segment. Excluding these beneficial effects, gross margin would have been approximately 31% and this is where we expect to be for the remainder of the year.

Looking at the bottom half of the slide on operating expenses which do will you both RD&E and SG&A -- they were up $88 million year on year driven by the increase in sales as well as increased performance compensation and pension expense which I discussed last quarter. Operating expenses were up approximately 8% versus the first quarter driven by further increases in performance compensation as the business has strengthened as well as increased investment in RD&E and some currency transaction losses we had in the quarter versus currency gains that we had in the first quarter. We effect that our RD&E will continue to be approximately 5% of sales and that our SG&A will decline by approximately $15 million on a sequential basis in quarter 3 and flatten out in quarter 4. As a percentage of sales our SG&A should approximate 13% for the rest of the year.

Turning to slide 9 let me discuss items on the P&L below the operating line. Net interest expense was $32 million versus $38 million in the prior year due to lower debt levels. Adjusted other income which relates to our tax agreement was $11 million compared to $3 million in the prior year. For quarter 3 I expect this will remain at approximately $11 million of income.

The GAAP effective tax rate was 31% in the quarter and the tax rate on adjusted income was 23%. This lower adjusted tax rate benefited EPS by approximately $0.04 versus our guidance. In quarter 3 and for the remainder of fiscal 2010 we expect a tax rate on adjusted income of approximately 26%. We also expect to be able to keep our adjusted tax rate at 26% beyond 2010 based on the planning that we have completed. And you may recall that when we separated from Tyco International our adjusted tax rate was in the mid 30's and our goal was reduce it by 200 to 300 basis points over three years. I'm very pleased with the progress we have made to bring the rate down much faster than we originally anticipated.

Now let me talk about cash flow, that's on slide 10. Our free cash flow in quarter 2 was $422 million, compared to $370 million in the prior year quarter and this increase was due to higher income levels and slightly lower capital expenditures. Our adjusted cash tax rate was 8% in the quarter and continues to be lower than our normal cash tax rate of 20% as we're utilizing net operating losses incurred in the prior year in certain international locations. We do continue to expect that our full year cash tax rate will be in the low teens.

Turning to our working capital metrics, we continue to have very good performance as business conditions improve. Our quarter 2 networking capital, which is receivables plus inventory minus AP days was 66 days, and that compares to 67 days last quarter and represents approximately a 20 plus percent reduction from where our working capital metrics were pre the downturn back in 2008. When you look at our day sales outstanding of 62 days it was down 4 days versus the prior year and 1 day sequentially. On inventory days on hand excluding contracts in progress we were down 20 days year-over-year and up 5 days sequentially to 63 days, which is where we expected to be. And we expect to be in the 60s as volumes stay at these levels.

On capital, we spent $81 million on CapEx in quarter 2, down slightly from prior year levels. We do expect our capital spending to pickup starting next quarter and will run approximately 4% of sales for the remainder of the year. And for the full year we expect capital spending to be about $400 million.

Cash restructuring in the quarter was $55 million and for the full year we now expect cash restructuring spending of approximately $200 million. When you take all of this we expect our 2010 free cash flow will be greater than $1.2 billion and that includes the restructuring cash outflow.

Let's move to slide 11 to talk about our balance sheet. We began this quarter with about $1.7 billion of cash and ended the quarter with $1.8 billion. Uses of cash during the quarter included return of capital to shareholders of $219 million, which included dividends of $72 million and share repurchases of $147 million. Also at our annual meeting that we held in March, shareholders approved four quarterly dividends of $0.16 per share starting with the third fiscal quarter of 2010.

As we discussed on the last call, we plan to increase our share repurchases in quarter 2 and during the quarter we repurchased approximately 5.7 million shares for $150 million. At the end of quarter 2 we still have approximately $440 million remaining on the current share repurchase authorization, and absent any significant acquisition activity, we would expect to use the remainder of this authorization in this fiscal year. And, finally, as we talked last fall, we did complete the acquisition of Sensitive Object during the quarter which resulted in a net cash outflow of $55 million.

Let me turn the call back over to Tom.

Thanks, Terrence. I will now give the third quarter outlook, talk a little bit about the full year outlook, and recap what we've just said and then we'll open up the Q&A.

For the third quarter we expect our sales to be in the range of $3 billion to $3.1 billion, which is up 20% to 24% year-over-year and 1% to 5% sequentially. Excluding the expected decline in our subcom segment, our year-over-year organic growth should be 30% to 34%, and 4% to 7% sequentially due to the increased strength in our Network Solutions and Specialty Products segments. Adjusted operating income is expected to be in the range of $395 million to $420 million compared to $410 million in Q2. The Q3 operating margin should be in the range of 13.2% to 13.6% and this is a slight decline from where we are in Q2 driven by the subcom margin decline which would expect was very high, unusually high in Q2. Our Q3 adjusted earnings-per-share from continuing operations are expected to be $0.61 to $0.65.

At this time we're also reintroducing a full year outlook. Sales are expected to be in the range of $11.8 billion to $12 billion for our full fiscal year 2010 which is a 15% to 17% growth versus the prior year and up 22% to 24% excluding subcom. And this translates into full year adjusted EPS from continuing operations which are expected to be in the range of $2.32 to $2.40 compared to $0.83 last year.

So just to wrap up -- I really feel we had a very good first half. Clearly economic conditions improved through the first half and we're encouraged by our order rates over the last quarter as well as the first month of this quarter. I think what we're equally feeling good about is the strong execution. If you compare us to when we launched three years ago, we have a much more focused business portfolio, much more efficient manufacturing footprint which we have reduced by 33% in that time and we're also better in the good old fashioned area of productivity. This has enabled us to improve gross margins to the 31% plus range and is clearly demonstrating better operating leverage in the company which was of the highest priority for us as we separated.

Cash flows will continue to be strong as we generate in excess of $1.2 billion this year. Stronger earnings, better management of our capital and continued improvement in working capital management. And then, you know, as we talked about a year ago when the business was difficult, we felt the best thing to do was to structure the business, take costs out, structure the business around a $12 billion revenue level that would generate 12% adjusted operating income.

I think that's turned out to work out pretty well for us an we're now running at about 13% at the $12 billion revenue level and I feel very confident that we have line of sight at 15% at a $14 billion revenue level. The way to think about that is that he will would look like this. Gross margins in the 32% range, R&D in the 5% of sales range, SG&A in the 12% of sales range, and that would also train traits to net income in the 10 plus percentage sales range and return on invested capital all in including goodwill at 20% plus. So I think we've got it teed up. We have to continue to execute, but we feel like all the work of the past three years has really started to kick in.

And then the last point that I think we're maintaining the right balance of keeping our strategic options open and returning cash to shareholders. As Terrence explained, we returned over $200 million in the quarter, but I think as we have consistently said, our priority is to continue to strengthen the company strategically. We took a step to strengthen our touch business last quarter and it's still early with that acquisition of course but we're excited about the prospects the next couple years and we're building an active pipeline, much more active than we've been here in the last three years, but I want to assure you that we're very thoughtful about what we're going to do with that pipeline and how we're going approach it.

So with that, a good quarter and let's open it up for questions.

Certainly. (Operator Instructions). And first question comes from the line of Amit Daryanani of RBC Capital Markets. Please go ahead.

Okay. Thanks a lot, good morning, guys. Maybe you should start off -- given the strength you guys have seen in your electronic component in the specialty products side, can you just talk about how much of the business direct versus through the channel? And are you seeing a material delta between your selling rates into the channel versus to the OEMs?

Hi, Amit. The normal split for our business is about 80% direct, 20% channel and what we consider direct is when we design in with the end customer. So in automotive that could be a product that ultimately goes through a -- a tier 1 but we're getting designed in by the end customer and I would say the second part of your question we're not seeing any material difference in the buy rates from either part of -- either category of the market.

Got it. And then nice to see the full year guide and you guys pulling in the 15% margin target on $14 billion in sales now. If I kind of work the math, roughly speaking, you guys are looking at about 20% incremental margin from the quarter you just reported. Could you just talk about -- go ahead ?

Sorry, Amit -- when you look at that, remember we did get some benefit out of our subcom business being 20 plus percent earnings and as we've said all along when it gets into where we guide it at $600 million to $700 million next year, it should be in the lower teens. So you do need to adjust out for that you would get in of that you know 13 less range that we've guided for the rest of the year more of a high 20% fall through rate that where you quoted.

Yes. That offsets that question there. So maybe a different one then. Could you just talk about what your current utilization rates are and given sort of the phenomenal book to bill guys reported today, at what trigger point do you need to start adding more capacity on a CapEx basis and increase your OpEx to meet uptick in demand?

Well, we have -- I mean we have been increasing OpEx in our factories and our supply chains and we're covering that with productivity. So there's no question that we are adding more people back to respond to the increase in demand and all the -- the supplies and everything that go with that. So that -- that is reflected in the current results. From a capacity point of view bricks and mortar were plenty good, absolute manufacturing capacity I think we're fine at the capital investment levels that Terrence talked about in the 4% to 4.5% range and the most variable part of our capital spending is the tooling that we spend, which is about half of our capital spending related to new programs. So if we win new programs that's the piece that varies the most. But we don't -- I would say we don't feel pinched on -- on capacity. Where there's pinch point and there are still some, there's less than there were a quarter ago it's more the extended supply chain of material. You know, that we're -- not delivering in some cases as fast as we would like, it tends to be the supply chain more than our pure manufacturing capacity.

Got it. That's help. Thanks a lot, guys.

Thank you.

If everyone could limit their questions to one question and one follow up. We have a lot of folks in queue and we want to make sure we get to them.

Okay thank you and next question comes from the line of Amitabh Passi of UBS. Please go ahead.

Hi. Thank you. My first question just has to do with your expectations for auto. Can you just remind us as you go from September to December what we should expect in terms of sequential changes in production? And then I just wanted to confirm as we look out from 2010 to 2012 do you still think that the 64 million production number in terms of units for 2010 and 73 million for 2012 is still what you're sort of planning for or your estimates right now?

Yes. Amitabh. It's Terrence. Let me take that. Where we've been is if you look at Q1 and Q2 car production, including light vehicles that we put in, ours was around 17.5 million vehicles built the planet these past two quarters. We do see a slight sequential downtick into the June quarter down to around 17 million vehicles and then we do expect to get into what is typical automotive seasonality down about 5% in production in Q4. And as I mentioned on the call, we view that with Q4 is when we'll get hooked completely back in with production is our expectation now.

For the year that -- that equates to those numbers equate to about a 68 million build level and current use of next year is more around low 70s, you know, 71 million is where we see it. So it is coming back faster than where we talked before. You know, we certainly have said 73 million, which was the 2008 level, more like a 2012 and looks like we could be getting there earlier in 12 from a production perspective.

And then just one follow up -- I am just trying to gets to the midpoint of your EPS guidance for next quarter. I was wondering if you could give us some commentary around OpEx and then the fact that you're going to exhaust the $440 million in your share buy back plan should we assume share counts down 6 million, 7 million, sequentially, or would there be some offsets there?

When look at our guidance I think the right way to think about it from what Tom and I mentioned is we did benefit from a lower tax rate this quarter. Next quarter's guidance which is about a $0.02 differential. SG&A that I talked about going down will add about a penny or two and then when the volume benefit really offsets the gross margin coming down a little bit. That's really how you get to the midpoint of our guidance. From a share count perspective just how it works it'll come down a little bit, probably not full amount that you mentioned just due to how the accounting gods make you average, but we are anticipating to use right now the rest of the authorization through the end of the year.

Okay. Thank you.

The next question comes from the line of Matt Sheerin of Thomas Weisel Partners. Please go ahead.

Yes. Thanks and good morning. So question regarding the gross margin. Sounds like it's somewhat capped at 32%, still pretty high. We're just trying to figure the components that go into that in terms of leverage going forward and in line with that could you talk about materials, pricing, copper and other costs that may be head winds going forward? And then also the ASP environment in terms of your pricing to customers -- given that demand is good are you able to keep prices firm or even increase prices in some cases?

Sure. Let me -- let me -- if I forget one of those remind me. If you start with the whereby where the gross margin level is as Terrence pointed out, a few benefits one related to execution, one related to business mix in the quarter. But the 31% we feel very good about. You know we have a wide range of businesses and products all related around connectivity and 31% is a pretty healthy margin. And think about 31% for the balance of this year. I mean we're it we don't feel we're limited at 31% or 32% necessarily but we've got too take one step at time to improve them.

In terms of head winds, you know, baked into our second half is some slight copper head winds you know copper at $3.35 is slightly higher than what it costs us in the first half of the year, where we benefited from fixed purchases we made. But fundamentally our -- the combination of our productivity programs and what I would call selective price increases because you know in this business every -- really every business quote that you have an opportunity to bid on, you have to factor in where you want to be in price. But having said that, pricing has been pretty stable all year. I haven't seen really much of a material change. You know, we're looking given where copper is at some selective increasing in the second half to offset that.

That's okay. Great. And then just as a follow up -- just looking at your guidance for the year it looks like you're expecting revenue to sort of flatten up and a little bit here and, Tom, could just give us a take on where you see demand playing out? Because obviously you're benefiting and other suppliers are benefiting somewhat from this inventory restocking that's been going on. And it's been -- you know, it hit consumer and auto first and now we're seeing in the industrial markets. So there's some lag there. But what's your sense of that whole inventory restocking, replenishment? And when do you think that starts to end? And when do you start to grow more in line with your OEM and EMS customers?

Well, the big one for us, of course, is automotive. You know, that's by far the biggest piece of our business that's affected by that and we see that getting in line next quarter. What you really start to look at where production and in the industry, the industry right now is calling as Terrence mentioned about 68 million vehicles produce around the world -- and about 68 million sold around the world in our fiscal year 2010. And so we get -- you know, we had less inventory related replenishment benefits in Q2 and that pretty much is done by Q3. We have a little dip in automotive in Q4 but that's the model change over for a lot of companies so that's typical seasonality.

If you look at the rest of our consumer businesses, consumer electronic, hand set while you know important or relatively small I think you can see largely through that cycle already. And industrial wasn't as much of that to begin with. Again, smaller pieces of market than automotive, but there wasn't so much. So I would say it's largely behind us now.

Okay. Great. Thanks a lot.

You're welcome.

And next question comes from the line of Jim Suva of Citi. Please go ahead.

Thank you and congratulations. My first question is a follow up I'll tell you the same time, too, but the first question has to do with the outlook of sales which is, know 3 to 3.1 is higher than the reported 2.6 this quarter. Yet the EPS guidance is you know you posted $0.64 but you're guiding $0.61 to $0.65 and I understand maybe a penny of tax, but it just seems like you have more sales, you have restructuring doing traction. Why wouldn't the guidance of EPS be higher? Is there some conservatism built in there or -- or kind of what's the disconnect between higher sales and not higher EPS?

Then the follow up question has to do with the undersea business. It seems like it's been several quarters in a row of discussions bidding on projects and I'm just wondering -- is it more of a funding issues that the different entities are having to fund some of these contracts? Or there's just a little bit of uncertainty in the demand environment is causing the mechanic reasons to cause some of these companies not to build out some more? Or are we just kind of at a structural lower level than we should think about here? Or potentially there's a build-up of additional contracts that should really help out at some point in the future? Thank you.

Thanks, Jim. Let me take your outlook question and then I'll ask Tom to talk about subcom.

When you look at it sequentially, the tax impact having a 23% tax rate which we had in quarter 2 to the 26% is actually a $0.02 differential, Jim. So when you look at that d that is an element that is a drag. The other element that we had that we talked about was the subsea over earning from a gross margin what it did on the rate. So with the gross margin coming from 32% to 31% that is about a $0.04 negative.

Offsetting those negatives when you think about it is the volume impact that you talk about, which sort of off the gross margin, slight down draft, and then the other benefit we have is SG&A coming down by -- by $15 million which is a couple of cents. So when look at those, there's two negatives, gross margin coming down, tax going up slightly, and then positives are the volume as well as the SG&A benefit that we talked will also be coming down.

Tom will talk about subcom.

Yes. On subcom as you know we came off a couple of really big years, billion dollars plus years which had several -- two really large contracts, one over $0.5 billion dollars and one over $300 million. There continues to be a fair amount of activity. I think there are some that are taking longer because of funding. You know, I think we're confident they'll eventually happen, that the projects end to be more in the $100 million to $200 million range. And I think in the sense the wild card is the visibility out beyond six months. I mean we know what our backlog is but typically the way the business works is the folks are deciding to build a network -- while they're in that process of deciding and gathering their funding and their business plan that is very -- there's very little visibility around that for their competitive reasons. Once they decide they want to go forward that's when they pull companies like ourselves in to give them a bid on how to do it.

So while these are big major strategic investments we don't typically have year or two year visibility to a pipeline. We tend to see it when, you know, folks have decided they're going to do something for sure and then they start the bidding process with us. But if you go back over the last three years, I think generally there's been more activity than we have expected. Again due to the visibility. And if you think we all know that that's really due to sort of the data any time anywhere and data rich transmissions, more video, YouTube, et cetera. So we -- our focus is to make sure we have the right balance of capacity and that we can capitalize on most of the upside and that we ensure in the event of a significant downside we're still profitable and better than cost to capital and that model has been working pretty well for us for the last four years.

Great. Thank you and congratulations.

Thank you.

Thanks.

Thank you. Next question comes from the line of Shawn Harrison of Longbow Research. Please go ahead.

Hi. Good morning.

Good morning.

First question just has to do with the revised I guess sales range for the 15% EBIT margin. If you could talk to maybe what's changed versus, you know, one to two quarters ago where you were looking at $14 billion to $15 billion in terms of maybe what's more profitable or maybe how the mix of business has changed a little bit to gets you toward -- to that target on a lower sales level.

Sure. I think -- with the, the main thing is the execution that's happening. We were confident that we would gets through things like the restructuring but when you're taking that much offline and moving it someplace else there's a bit of risk. The clean up of the portfolio has certainly been a major contributor. I think we're better at pricing for value than we were two or three years ago and we're getting the leverage in the Electronic Component segments.

I think that's -- if I had to pick one thing that the businesses there really have done an excellent job there of getting the cost out and as -- as the business comes back and the revenue ramps, managing extremely effectively through productivity that these groups have been working on for three years now. We're much more productive than we were. So I think that's the combination of those things but if I had to say hey, which exceed your expectation, Tom, the most it's -- it's the productivity we're getting in the day to day running of the business that contributes most to that point improvement. The 13 and 12 that's now giving us the confidence to talk about 15 to 14.

Okay. And then to that and then just a brief follow up question -- is there a different you know global automotive sales run rate you're looking to get to that $14 billion? And then my follow up question is just on the later-cycle businesses, the Specialty Products and network solution. Just maybe if you could characterize you know what you're seeing over the next six months and kind of what inning you believe you're in terms of the recovery there. Thanks.

Shawn, when you talk about a different automotive run rate, I assume you mean different growth rates in the regions?

Either growth rates in the regions or global production number. I think you know previously that 15% you were using kind of a mid 70s global production number.

I would say it's -- it's really -- you know it's still in that 73, 74 million units range. So that's a little bit -- that's a little bit better I mean that's happening faster as Terrence said and plus our operating leverage is a little bit better in that business than, you know, where we thought we would be six months ago. So that's a combination. And then we're doing extremely well in the emerging markets in automotive. There's -- and there's nice leverage there as well. In terms of the late cycle businesses I'm not -- I'm not counting on anything extraordinary, but I am counting on them get back to be a growth profile in the second half of the year. You know, 10% second half versus first half and then getting into their portion of the recovery for SPG and Network. But I would say that what has really given us the confidence to go from 15 -- between $14 billion and $15 billion in revenue say it's going to be around $14 billion is we are getting the productivity and we're especially getting it in electronic components.

Thank you very much and congrats.

Thank you.

Thanks, Shawn.

Thank you. Next question comes from the line of Brian White of Ticonderoga. Please go ahead.

Yes. Good morning. I'm wondering if you talk a little bit about the trends that you're seeing by geography and specifically for auto.

Sure. I would say starting with Asia as we alluded to just in credible growth in China. Two weeks ago I visited one of the local Chinese OEMs in a small town of 3.5 million people four hours from Shanghai and 12 years ago they were starting the business and now they're -- if they were producing in the US they would be No. 3. So it's -- it's happening. The infrastructure is being built quickly over there. That drive, that four hour drive was on a six line divided highway. So it's moving quickly and people want to own cars there. Japan as a -- not as a consuming country per se but as a manufacturer of automobiles is picking up again so the exports are picking up as well as pent-up demand in Japan. So Asia as a whole is really solid up 25% solid double digit growth for us right now.

Europe has been solid growth for us, you know, and I think we expect that, especially Europe and the US to go more into the seasonal slowdown in Q4, but I think you've heard the numbers recently of companies like Ford where sales are strong and most folks are attributing it to it this people are feeling better and there is pent-up demand. So it's a -- we feel things are going to start leveling off around this 17 million for the next couple quarters but that's a pretty robust level compared to where we thought we would be six month ago.

Brian, to give you maybe -- to add to what Tom said if you look at the 68 million vehicles we quoted, that's up about 20% versus 2009 and certainly Asia overall is up almost 30% in that with China certainly out earning Japan and Korea. Certainly we have the rebounds in North America for production. We see North America production to be up 30% this year. And then EMEA is up you know low double digits around 12% from a production level to sort of get you into some of the numbers there.

And if we look at this recovery, so this started restocking, there were some incentives and people thought auto sales would drop off after the incentives. They haven't. Do you believe the auto market has entered a new cycle and how would you compare this cycle versus other cycles?

Well, I wish I knew. I hope they are, but I think it's still too early to tell. I would say the indicators are positive that, you know, you could -- it wouldn't be unrealistic to think about a normal growth profile next year for vehicle production and for our business in relation to that. But you know we don't have any unique view beyond the next two quarters.

Yes. Brian, there's been no cycle like this in the automotive industry history. So typically and we talked about it before -- the auto typically gets to pre-recessionary builds. You know we talked about four years after but we've never had anything as deep as what we went through last year. So certainly everything that we're seeing does feel quicker, but to Tom's point there's never been a cycle where we have seen what we went through last year, but it is trending quicker based upon what we see in the short term.

We also didn't have China like we do today and we also didn't have the move to hybrid electric automobiles probably there.

That's fair.

To that point, Brian I think, so if you get away from what do we think the numbers are going to be in the next year it's hard to call -- we love the fundamentals. I mean we love the fundamentals that you know half the world has only been driving for a few years really and electronics is going to continue to proliferate and -- and you look at these cars that are being made by the Chinese OEMs I mean they're not low content cars. They're not near the European car content average, but content is moving up. People like features and they decided to buy a car they typically want several of the features. Then you lay in on top of that hybrid vehicle, electric vehicle, electronic contents goes up. That benefits us. So we think the fundamentals in the business are really, really good over time and of course they're good right now as we're in the recovery stage.

Okay. Great. thank you.

Thanks, Brian.

Next question comes from the line of William Stein, Credit Suisse. Please go ahead.

Thanks. I was wondering if you could talk about inventory a little bit. It was up about 6% in dollars in 6 days in the quarter. Can you give us an idea of what we should expect going forward? And also can you quantify the impact on profitability in the quarter from the inventory build?

When you look at it, the impact on the quarter was nil.

Okay. I mean we'll just take that first. Secondly, when you look at it we have been saying that as the business came back and as we wanted to make sure we were serving our customers we would be getting back in the 60s. So as you model I think you have to model it about where it's at from a metric perspective certainly it will move with volume. We do expect it to say where it's at about right now.

Great. Helpful. One more if I can on the restructuring side. It sounds like you're talking about new charges coming in that might not have been formally announced as kind of a new restructuring program. Do I have that right? And can you give us an idea for how big this one is going to be and what the impact on a kind of say standalone basis excluding the leverage?

If we left anybody with that impression, we left you with the wrong impression. I would say it's just the opposite. We have really last year as I think we told everybody was the peak of the restructuring. It's come down and we -- we executed that plan a little ahead of plan. So we're getting close to where we think we need to be given where the outlook of the business is. You know, there's always going to be fine tuning in a business like this, but think of us as well past the peak of restructuring and no -- no big new restructuring programs to be announced.

Yes. What I mentioned during the call, Will, is consistent with what we have been the major program winds down there's nothing new.

So the charge that's going to happen next quarter and I think this was a little bit more in Q4 that you implied that's just a hold over from stuff that's already been announced. Is that right?

Correct.

Great. Thank you very much.

Thanks.

Rochelle, we're showing nine-thirty, so we'll take one more question.

Okay and the final question comes from the line of Craig Hettenbach of Goldman Sachs. Please go ahead.

Thank you. And nice to see the buy back activity. A lot of other companies have been slow to do that. But what does that say just about the M&A environment and potential pipeline out there and how should we think about capital allocation going forward?

I think the way to think of -- I am sure the way to think about our capital allocation is the dividend first. We used to say the debt levels first but that's behind us. The dividend first, strategic moves to strengthen the company. And not that we're ruling anything out, but as we've said often, I believe, that for the right opportunities would like to do that in Networks and our Specialty Products business. And then to the extent that those opportunities don't presents themselves or they don't present themselves on a timely basis, we would return capital to shareholders. We have about $440 million left on the current buyback and so as Terrence said absent any -- anything that would take priority over that you can expect that to happen over the balance of the year.

But clearly we have been spending a lot more focus over the last year building the pipeline. Two years before that no question our priority was to get the business focused and the structure very sound so that we could grow faster organically. I am very encouraged about the organic opportunities in the company. And I mentioned, you know one big one I mentioned is China automotive but which feel there is a number of other ones there. That has remained our top priority but with the cash level we have we have clearly looking at opportunities in our pipeline. Now, I think it would also be fair to say that we're probably going to be around the current cash level. We wouldn't build that much more. So that in conjunction with the $440 million left on the buyback authorization from last year is how I would model it if I were you for now.

Okay. And then as -- on the follow up the strength you're seeing in the industrial market is that really just a broad macro recovery or is will anything specific to Tyco from a design win perspective that's driving some of that strength as well?

I think it's more -- it's definitely more strength in the market than any particular design win. I mean we're having success there, but that's a very fragmented business. So that's very customized. It's not a business where you introduce a platform and you get hundreds and millions of dollars of revenue from it. It tends to be kind of a one-off customize the business. And it's coming back as people are buying capital equipment again. So that's the big driver.

Got it. Thank you.

Thank you very much. Thanks everyone. For calling in and we'll talk to you soon.

Thank you.

Thanks everyone.

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