泰科電子 (TEL) 2011 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the TE Connectivity reports fiscal second quarter results conference call. At this time all participants are in listen only mode. Later we will conduct a question and answer session. Instructions will be given at that time.

(Operator Instructions)

As a reminder, this call is being recorded. I would now like to turn the conference over to our host Mr. Keith Kolstrom, Senior Director of Investor Relations. Please go ahead .

Good morning, and thank you for joining our conference call to discuss TE Connectivity's second-quarter results for fiscal year 2011and our updated outlook for the full year 2011. With me today are CEO, Tom Lynch and CFO, Terrence Curtin.

During the course of this call we will be providing certain forward-looking information, and we ask you to review the forward-looking cautionary statements included in today's press release. In addition, we will use certain non-GAAP measures in our discussion this morning, and we ask you to review the sections of our press release and the accompanying slide presentation that address the use of these items. The press release and related tables, along with the slide presentation, can be found on the investor relations portion of our website at te.com.

Finally, for the participants on the Q&A portion of today's call, I would like to remind everyone to please limit themselves to 1 follow-up question to make sure we are able to cover all questions during the allotted time. Now let me turn the call over to Tom for some opening comments.

Thanks, Keith, and good morning everyone. Before we get into the detail of the call here I would just like to make a few opening comments about the earthquake in Japan. As many of you probably know, we have a very sizable presence in Japan and we feel very fortunate that all 2,000 of our people there came through the earthquake safely; and I really want to thank them in this venue for their commitment to keeping our operations running and supporting our customers during these incredible -- incredibly trying times over there.

Just a little background on our business in Japan; we have been there for over 55 years; we have 3 factories; we generate over $1 billion of revenue annually there, serving virtually all the major customers in automotive, communications, industrial, and the consumer electronics industries. And about 50% of our revenue there relates to our automotive business; and, as we will talk about today, you can imagine there is an impact to our business over the next couple quarters from the unfortunate circumstances there.

Now if you will turn to slide 3. A few quick comments about the quarter before I turn it over to Terrence. Our sales of $3.5 billion were up 17% over last year and 7% organically. Our sales benefited from the ADC acquisition which added about $279 million of revenue compared to the prior year. Adjusted earnings per share of $0.71 was up 11% over last year. And, both sales and adjusted EPS were in our guidance range.

Japan did cost us about $0.01 in the quarter. It happened late in the quarter, as you know . And, as we will talk about later, currently our estimate is that the impact is going to take about 3 million vehicles out of the global production forecast for the year.

Overall, I would describe Q2 as a solid quarter for us. The quarters were strong in our automotive, industrial, and networks businesses, and our overall Book to Bill, excluding our SubCom business, was 1.05. So, I feel very good over -- about the trends leading into the second half of the year when, notwithstanding the circumstances in Japan, we expect to see a nice pick-up in revenue and earnings. The ADC acquisition integration is going very well, and we are on track to deliver our sales and adjusted earnings goals for the year of $1 billion and $0.12 per share. And, importantly, and we talked about this on the last call, we were also awarded a $400 million 5-year contract to supply equipment for the Australian national broadband network; and this is the first big award leveraging the benefits of our combined product line.

So, we feel very good about the timing of the ADC acquisition, both from an ability to stay on track with the significant cost synergies there, as well as the very robust product line it is giving us. And we had another excellent cash flow quarter, generating about $450 million of free cash flow; and, as a result, we have now increased our full-year guidance on cash flow by about $100 million. So, we expect to do $1.3 million -- $1.3 billion in free cash flow for the year.

A quick comment about our outlook, and we will cover this in more detail year later, right now our adjusted EPS outlook for the year is now 295 to 307. A quarter ago we got it to 305 to 320, so the change -- the entire change in our outlook and the reduction in our outlook is due to our estimates of the impact of the earthquake in Japan on our business. And, as you can imagine, it's -- it's not easy to get your arms around this, so we will talk about that quite a bit over the call and I'm sure that will be a big topic of the Q&A. We do expect a majority of the impact to be in our third quarter and, as I said, we will talk about Japan in more detail -- or the impact of Japan in more detail. Let me now turn it over to Terrence Curtin, our CFO, and he will walk you through the second quarter in a lot more detail. And then I will close by covering the

Thanks, Tom, and good morning everyone. Let me start by giving an update on the sales front, and if you could please turn to slide 4. Total company sales during the quarter were $3.5 billion, and this was up 17% year-over-year with growth across all segments and geographies. If you exclude our SubCom business and ADC, growth was broad-based across all the regions, with EMEA up 14%, the Americas up 10%, and Asia up 8%. As Tom did mention, ADC added $279 million of sales during the quarter, and we did also benefit slightly from currency translation year-on-year.

Currency translation increased overall growth by approximately $40 million or 150 basis points. We did have a slight negative impact in Japan in the second quarter. That impacted our sales by approximately $20 million, mainly in our CIS segment.

When you look on a sequential basis from a growth perspective we were up 9%, mainly driven by the ADC acquisition, and, excluding the ADC acquisition, on an organic basis, sales were up 1%. This growth, on an organic basis, was driven by the industrial, our network infrastructure, and our automotive markets that drove it, and they were partially offset by declines in our consumer devices business and our CIS segment.

So, let me get into the segments and the key markets in each of them, starting on page 5; and, unless I indicate otherwise, all changes I will discuss will be on an organic basis. So, on slide 5, looking at the transportation solutions segment, sales were in line versus our guidance. Sales increased 14% versus the prior year and were up 3% on a sequential basis.

In the automotive market, our sales increased 15% versus the prior year and were up 3% sequentially. Year-over-year sales were up 20% in EMEA, 19% in the Americas, and 8% in Asia. Global vehicle production during the quarter was 19.5 million units, which equates to a year-over-year production growth of 5%. Our sales growth at 2 times plus the production growth was driven by our leading global position and by increased content per vehicle.

The end-demand trends we see outside of Japan remain strong across all regions. However, for quarter 3, current estimates are that auto production will be affected by about 2 million vehicles compared to quarter 2, and about half of this vehicle impact is in Japan and about half outside of Japan, and it is driven by OEM slowdowns resulting from the impacts of the earthquake on the automotive OEMs and their supply-chains.

Taking into account this expected decline, global auto production is expected to be about 17.5 million vehicles in the third quarter. This equates to a production decline of about 6% year-over-year and 10% sequentially. The expectation we have for our auto sales and for quarter 3 is that it will decline slightly less than these production declines. We expect the effect of these disruptions to be temporary and combined into our third and fourth quarters; and, as global auto demand remains strong outside of Japan, we do believe we could see at least a partial recovery of the lost production early in our fiscal 2012.

In the other market we serve in the transportation solutions segment, the aerospace and defense marine market, sales were up 7% versus the prior year and up 4% sequentially. This is driven by the continued improvement in the commercial aerospace and marine markets, as well as increasing market share.

For the transportation solutions segment overall; we expect that our revenues will be down slightly versus quarter 2 levels, with the continued improvement that we expect in the aerospace defense and marine markets to offset mid-single digit declines in automotive, where the earthquake in Japan is expected to have an impact on our revenues of about $100 million in quarter 3.

So, let's turn to slide 6 and I'll talk about communications and industrial solutions segment. Sales increased 3% versus the prior year and declined by 1% sequentially. Strength in the industrial and data communications market, where our growth was about 10% year over year, was partially offset by declines in our consumer devices and computer businesses. So, let me get into these markets in more detail.

In the industrial equipment market, sales growth of 10% versus the prior year, and 2% growth sequentially, was really driven by the continued recovery in capital spending trends, which drove strong demand for factory automation, as well as rail projects in the emerging markets.

In the Datacom market, which we include sales to the communication equipment, server and storage markets, our sales increased 10% year over year, driven by new program wins and spending on broadband infrastructure and data storage equipment. Sales were down 3% on a sequential basis; this market has been developing slower than we expected, but, based upon current order trends, we do expect it to improve in the second half of the fiscal year.

In the consumer device area, our revenues were down 15% versus the prior year of 17% sequentially. Our sales decline is due to our customer mix and our relatively small portion in the smartphones market, which is certainly the fastest-growing portion of the mobile phone market. We do expect that in the second half our business in this area will pick up in line with normal seasonality.

In quarter 3, we expect that the revenues in the communication and industrial solutions segment overall will be similar to quarter 2 levels, and we do expect a negative impact of Japan of approximately $35 million. This impact is really driven by where we service our local customers in Japan, which is about 50% of our total Japan revenue that Tom talked about.

Turning to slide 7, to cover network solutions; total sales were up 51% including ADC sales of $279 million. On an organic basis, sales in the segment, excluding SubCom, were up 20% versus the prior year; and, as expected, our SubCom business was down 28%. Sales to the telecom networks market were up 33% organically versus the prior year, driven by the continued acceleration of fiber network builds; and we especially saw this in Europe and South America. Our sales reflect that the growth that we continue to see in the telecom carriers' investment in their fiber optic networks support the data and video needs on their networks. Sales to the energy market were up 12% versus the prior year, with particular strength in Europe; and we continue to see steady improvement driven by the recovery in this market around the world.

In the enterprise area, our sales increased 20% versus the prior year, on an organic basis, due to the increased data center spending and growth related to infrastructure build-outs in emerging markets. And, lastly, in the SubCom business; as I mentioned, sales declined 28%, as we expected, versus the prior year. Bookings in the quarter were $30 million; however, earlier in April we finalized the Singapore, or SGAC, contract, which will add $180 million to our backlog. This is one of the pending contracts that I have covered on prior calls; and we are still in active -- in discussions on a number of other bids and contracts that are in process; and we continue to expect full-year 2011 sales of $600 million to $700 million, with quarter 3 sales about $160 million.

On an overall basis, for the network solutions segment, we expect our sales to be up about 10% on a sequential basis compared to quarter 2. Certainly, we are entering the seasonally stronger quarters for these businesses, and we continue to see strength in all regions.

So, now let me turn the call to discussing earnings which starts on slide 8. Our GAAP operating income for the quarter was $405 million, which includes $48 million of charges related to the acquisition of ADC. Also included was $4 million of income related to the reversal of prior non-ADC restructuring charges. Of the $48 million of ADC charges, $18 million is cash related and $30 million are non-cash charges, primarily related to fair-value purchase accounting adjustments of inventory and backlog. I do want to highlight that these non-cash charges of $30 million are reflected in gross margin across the sales on -- in our GAAP income statements. In quarter 3, we do expect approximately $10 million of additional ADC charges, which will be primarily cash charges and in line with our original integration plan.

Adjusted operating income was $449 million, with an adjusted operating margin of 12.9%. Sequentially margins were down, as expected, primarily due to the impact of ADC and metal headwinds I discussed on the last call. In addition, our margins were down slightly from where we guided, due to the lower than expected sales in the consumer and Datacom businesses in our CIS segment.

Adjusted earnings per share for the quarter were $0.71, and this was up 11% from $0.64 in quarter 2, 2010. The improvement was driven by the leverage on our sales growth, the acquisition of ADC, and the benefit of share repurchases, which together more than offset the impact of higher metal costs and the $0.01 that we talked about relating to the Japan earthquake.

So, let's move to slide 9. And, starting with gross margin on the top half of the slide, our adjusted gross margin in the second quarter was 30.9%. As I stated, the GAAP gross margin includes the $30 million of fair-value purchase accounting adjustments that I just highlighted; and this 30.9% was in line with our guidance of 31%. In the third quarter, we do expect our gross margin to be about 30.5%, which will be down sequentially as we incur about 50 basis points of headwinds due to the impact of the reduction in sales and the inefficiencies caused by the earthquake in Japan. When you look at the Japan inefficiencies that we have, we have 3 factories in Japan that are dedicated to the Japanese market; and, we expect that, as this is a fluid situation, we will have inefficiencies that will create the flow-through on the sales to be a little bit worse than we typically would expect.

In the fourth quarter, we do expect our gross margin will be back above 31%, due to higher volumes and the benefit of our pricing actions that partially offset the raw material price increases that we've been experiencing this year. We also expect that in the fourth quarter we will see a reduced impact from the Japan earthquake on our gross margin.

Looking at the bottom half of the slide, operating expenses were in line with the guidance expectations of 5% for RD&E and approximately 13% for SG&A. Expenses were up $77 million year-on-year, driven primarily by ADC and also our increase in volume. In quarter 3, we expect that, as a percent of sales, our RD&E and SG&A will be similar to the quarter 2 levels.

Turning to slide 10, let me discuss the items on the P&L below the operating line. Net interest expense was $37 million in the quarter, compared to $32 million last year. The increase is due to ADC-related financing costs. Specifically, we issued $250 million of new debt for the acquisition, and we also had interest cost on the acquired ADC debt prior to completing the tender to repurchase. In quarter 3, we expect net interest expense of approximately $35 million.

Other income, which relates to our tax sharing agreement, was $6 million in the quarter, which was below our guidance of $12 million as a result of the settlement of certain international shared tax matters. For quarter 3, I expect around $13 million. The GAAP effective tax rate was 20% in the quarter and the tax rate on adjusted income was 24%. The adjusted rate was slightly lower than the guidance rate of 26% due to the settlement of the shared tax matters I just mentioned. The key that I want to highlight is that the lower Other income and the lower tax rate offset each other; so, when you look at it, there is really no benefit to our EPS in the quarter versus guidance related to these items. And, for the remainder of 2011, we expect our tax rate on adjusted income to be approximately 26%.

So, let me turn free cash flow on slide 11. Our free cash flow in the quarter was very strong at $447 million, and this puts our year-to-date free cash flow at approximately $0.5 billion. With the progress year-to-date, we are increasing our 2011 free cash flow expectation to be in excess of $1.3 billion, excluding the ADC acquisition related spending. And this guidance is about $100 million higher than our prior guidance.

On working capital, receivables and payables are in good shape and we were at 65 days and 58 days respectively. On inventory, as we stated on the last call, we do expect to bring our inventories lower by the end of the year. Capital spending was $114 million in the quarter, up from prior-year levels of $81 million, and we expect capital spending for the full-year 2011 to be approximately 4% of sales.

Tax restructuring, excluding the ADC acquisition; cash costs in the quarter was $15 million and approximately $40 million year-to-date. For the full-year, we expect approximately $80 million of non-ADC cash restructuring. For acquisition-related cash restructuring for ADC, the spending in the quarter was $15 million and for the full-year we still expect $105 million. And we have spent about half of this amount year-to-date.

So, let's move to slide 12 that shows debt and liquidity. We ended the quarter with about $1.2 billion of cash. Uses of cash during the quarter included the repurchase of ADC convertible notes that were tendered during the quarter for $470 million and the return of capital of $306 million to shareholders, through dividends and the repurchase of about 6.8 million shares. We still have $570 million remaining on our repurchase authorization and, if we don't have any other strategic uses for the remainder of the year, we could see that we use that authorization up by the end of our fiscal year.

Couple things that happened after quarter end that I want to highlight; we did have an additional $88 million of ADC convertible notes tendered, and with this additional tender, our total debt will be about $2.65 billion. Also in April, we announced the completion of the sale of non-core patents acquired as part of ADC for $75 million. These proceeds will not be included in our quarter 3 free cash flow, but the sale demonstrates how we are working on maximizing the return on the ADC acquisition as we continue to work on the integration; and, certainly, the integration remains on track. So, with that, let me turn it back to Tom, who will cover the outlook.

Thanks, Terrence. If you turn to page 13, I will talk real quickly about our orders. As you can see from the chart, and as I mentioned earlier, our demand trends are strong in most of our businesses; of course, there is going to be a little bit of an offset to that -- a bit of an offset to that -- from the reduction in orders, primarily related to Japan. I think the key point on this chart is that these trends really give us the confidence around the increase in sales we expect in the second half ex Japan. So, the backlog is building and it's building pretty much across the board.

If you turn to slide 14, and walk through the third and fourth quarter outlook; we provided a little more detail here than we normally do, because there is probably more moving pieces, particularly with the Japan situation. But, to summarize Q3, we expect our sales to be in the range of $3.5 billion to $3.65 billion. This is an increase of 13% to 18% over the prior year and relatively flat with Q2 levels. This does include $320 million of revenues from ADC and, as Terrence mentioned earlier, the negative impact of about $135 million of revenue in Japan.

We expect adjusted EPS to be in the range of $0.68 to $0.74. This range is a little wider than normally due to the uncertainty around the effect of Japan, which we currently estimate to have a $0.09 negative impact. The reconciliation on the left side of the slide lays out the key elements. I think the real key point here is that, excluding Japan, we would be at a mid-point of around $0.80, which is right where we were a quarter ago when we gave our full-year guidance. That is what we were expecting; in the third quarter we -- this the quarter we expected to see the sales ramp. In fact, if you go back as far as when we did our original guidance in November, this is how we really expected the year to play out. A few puts and takes in there; but, overall, the year, with the exception of Japan, playing out the way we thought.

If you turn to the right side of the chart, we are providing an extra quarter's outlook here; again, to give you a little more granularity to understand the flow . We expect sales to be in the range of $3.8 billion to $3.98 billion. This is an increase of 22% to 27% over the prior year. And, we expect EPS to be $0.83 to $0.89, up from the mid-point of $0.71 in the third quarter. Now, this improvement from Q4 over Q3 reflects the benefits of the pricing actions that really start to take effect late Q3, a less impact from the Japan situation and our 53 week . And, we also expect our operating margins to back at that 14% range in Q4.

If you flip the page to page 15; a real quick snapshot of what all this means in terms of the full-year. I think the main point here is, despite the impact of Japan, we expect it to be a strong year with adjusted EPS growth of 16% to 21% . And, if you look at the reconciliation we have on the lower left-hand side of this page, you get a sense of the big levers in the business. I think the real positive thing here is you can -- you see the contributions of the volume, the ADC acquisition, and the benefits of our cash flow more than offsetting the metals cost increase this year and the Japan disruption.

And, then when you think about it, from the second half, we've got strong orders going into the second half, we've got the price increases going into the second half, and that is a day-to-day thing. You've got the contribution of $0.10 in the second half from ADC, and then you have another strong half of cash flow. So, this is enabling us to, despite the situation in Japan, have a nice pickup in earnings.

When you wrap all this up, I feel good about the earnings power of the Company . Several key earnings drivers that are very powerful for us this year, and we expect them to carry forward into the future, which is strong positions in markets with attractive growth prospects. We go through our portfolio, I think we feel good about our position in 90% of the markets we are in, both from the market drivers, as well as where we stand and the momentum we have.

We do need to improve in the consumer side, which is about a little less than 10% of our business. The operating leverage in the Company is better than it was several years ago, with all the restructuring and portfolio cleanup that you are familiar with. And we're running -- we're generating more cash in this business, which gives us the opportunity to do things like ADC or smaller bolt-on acquisitions that can contribute to EPS or return more capital to shareholders, and, as we mentioned, that's been about $400 million so far this year. So, with that, Operator, let's open

Thank you.

(Operator Instructions).

Our first question comes from Amit Daryanani. Please go ahead.

Yes, thanks a lot. I really appreciate the EPS bridge you guys provided, but I still have a question around the auto production. Could you just talk about the possibility of feasibly picking up this $3 million loss in December and through fiscal 2012 and, if you do do that, would we expect the same kind of 40% contribution margin on that pickup given we are seeing 40% so detrimental margins in the June quarter based on the guidance you provided from those lost units?

Yes. Thanks, Amit. I guess two parts to that question. The first part, we would expect demand to recover over time, particularly I think it is a little harder to call the in Japan demand, because of all the disruption in the country. We would expect that's going to take longer, so that the cars that are not sold there in the second half of our fiscal year, I think that 'll take longer to come back. But, we would expect, much like we saw after the big downturn two years ago in the auto industry, the pent-up demand is pretty resilient and comes back pretty fast as the production is there.

So, I would -- if we lose 3 million cars in the second half of this year, we would expect to get two thirds of that back in the first half of next year. I think that's what the experts are saying and we are talking to our customers that's what we would expect. I think you can expect the margin flow through of similar on the upside because we're not going to lay in any extra costs. So, what's really happening now is as the volume goes down, we're not taking people out of the factories in Japan, for obvious reasons . And, as it comes back, we wouldn't expect we're going to need to lay an extra variable cost to meet the volume. So, I would expect a similar flow through on those

Got it, that makes a lot of sense. And, then, just on the com and industrial side, it looks like modular down about 280 basis points sequentially, can you talk about what drove that? And then the price increases you are implementing, could that help you in the segment because you do have a lot of consumer assets there where I imagine pricing is tougher to flow through?

Yes, margins were down. I think we expected about, we expected most of that because of what we saw in the mix of our business, I think there was a little worse than we thought because volumes were lower in consumer and Datacom especially. And I think Datacom is an industry, more of an industry issue although Datacom grew year-over-year wasn't as much as we thought consumer, we just don't have a strong position there.

So, yes a little more margin pressure than we thought, so you have less volume to offset the price erosion in that business in the metals. We do expect improvement by the fourth quarter. Datacom, again, would be more market demand whereas consumer hits us, establishing a little bit of beachhead in some of these markets that we're just not participating in today. So, our consumer business will take a little longer to improve, but, overall, we expect CIS margins to improve by Q4.

Perfect, thank you.

And, our next question comes from the line of Shawn Harrison with Longbow Research. Please go ahead.

Hi, good morning. I just want to look at the September quarter in terms of maybe the factors driving revenues higher sequentially, knowing that it is typically a seasonally weak quarter for you at least in Europe, but the guidance suggests a significant ramp and volumes, some of that will be automotive coming back. But, maybe you could speak to the end markets where as you exit the fiscal year you have the most wind in your sails.

Shawn, it's Terrence. A couple of things, first off, when you look at the fourth quarter guidance you are looking slide 14. Remember, we do have an extra week in this quarter. So, that's about $250 million and that is not included in the organic calculations. So, number one, you have to remember there is an extra week due to how our fiscal calendar and our fiscal year is.

Excluding that, what we see is remember Japan is improving, we do expect the Japan affecting quarter three to be $135 million, quarter four about $65 million. So, we do see some of that will offset your normal seasonal patterns and then we do, as we talk about in our CIS business, we do expect, based upon the trend we're seeing, that they will improve and their typical -- and that is the way they typically seasonally improve. So, really the factors are, remember we have an extra week, the Japan impact lessening, some of the rebound in the production coming back in auto, and, then, lastly, the CIS market. In the network solution market, we would expect that would be relatively flat Q3 to Q4.

In the NBN project of for network solutions is it more of a 2012 and beyond contribution?

When you look at that contract, as Tom covered, it is a five-year contract, when you look at it will have very little contribution for this year. It will start to ramp next year. As the program really starts to roll. So, very little impact on this year.

Okay and then as my follow-up question. Just on commodities, you had some price increases through some markets at the beginning of this calendar year. Looks like you may get some more pricing as the year continues to progress. Where do you think you'll be in terms of --

Did we lose him?

Operator?

One moment please.

Okay.

The line is still open

Can you hear me?

You dropped off.

The question was basically a commodity recovery, you've been getting pricing --. Starting the calendar year, it looks like through out the calendar year's as well. Where do you think you will be in terms of price recovery? I know you have been targeting a higher ratio, do you think you will be toward that upper end of the ratio as you exit the fiscal year, exit the calendar year?

When you look at that, yes, we do. So, right now the progress we have, as we talked on last call, was you all know that it takes about six months lag, so we did start that full price initiative starting last quarter, we do expect to start getting that recovery bigger impact as you can see on the walks that Tom walked you through in our fourth quarter, and it will be towards that 60% to 65% recovery rate that we mentioned before.

Okay, thank you very much.

Thanks, Shawn.

You have a question from the line of Craig Hettenbach with Goldman Sachs. Please go ahead.

Yes, thank you and thanks, Tom, for all the color and detail around the impact to automotive. Taking a step back from automotive, can you just talk about the other end markets, how they are playing out today versus when you went into this calendar year? Areas that maybe you are seeing some upside to growth and other markets that might be lagging?

Sure. I would say for us, our networks business are a little stronger than we thought. We expected -- we saw the signs because of our RFP activity that they were going to pick up. And they had been, as you know, kind of soft for a few years, so we expected a pick up. And, I would say a little bit stronger there in energy telecom networks which is down for the big carriers and in enterprise. So, that's a positive I would say. You mentioned auto, auto's definitely a little bit stronger than we thought and we expect it to be pretty robust this year.

Overall, the Datacom business, which is selling to the companies that provide the gear that powers the Internet, that has been mixed for us, I think overall the year is going to be okay. But, probably a little slower than we thought and we attribute the first half of that more the -- that got hot in the middle of last year and I think we laid out that there's probably a little bit of inventory in the channel, not anything too over the top. So, I would say that one has been a little bit less than we would have thought and consumer a little less than we thought. We didn't have very high expectations because we know we knew where we were coming into the year on the platforms that were gaining momentum and we weren't very well-positioned, frankly, on the winning platforms. So, that is one that we knew was going to take us awhile to regain our momentum, but that has been a little softer. So, overall I would say revenues balanced slightly better, notwithstanding all the impact in Japan.

Okay. If I could just follow up on the consumer piece. Is that something that the strategy will be organically to improve that? Or is that indeed a strategy? And, could you address that through M&A as well?

I would say think of it as primarily an organic strategy. We have had intermittent success in that business over the last three or four years . I would say five or six years ago in the mobile side of it, we really did not have a position, and then we had a fair amount of success with two of the largest mobile phone suppliers. But, our product line wasn't broad-based enough.

We need to -- we have a nice road map now, but most of this is stuff that is just an extension of our normal connectivity. I would not expect -- you shouldn't expect us to do anything significant around M&A in this. I'd never say never, but we believe that there is attractive relative improvement just by executing

Okay. Thanks for that.

Thank you.

We have a question from the line of Jim Suva with Citi. Please go ahead

Thank you and congratulations, gentlemen, to you and your team for great results, especially considering the Japan challenges out there. And my view, the Japan issue, you guys have very much done a stellar job at clearing it all up, so maybe I will ask my questions on a different sub market or subsector.

The first part of the question is two parts and then I will be finished is, on the sub sea communications, looking out you've got some nice new wins there. Can you help us understand, it is tough to know what is rolling off the pipe as far as what is coming onto the pipeline, about what we should expect there for linearity for the next few quarters or maybe even 12 months or so about folding in new contracts versus rolling off?

And, then, the other part of the question is on the consumer devices, definitely you've done very well on other segments, but this segment, to be honest, appears that either a, you're losing so much share, do you plan to exit and close it down? Or how do you plan to fix it or what's really the recovery plan, because down 15% year-over-year, one's got to say that the market is no where close to accepting that as what organic growth should be. What is the plan going into the consumer segment that you see?

Let me hit that one first and talk just a little bit about it. No, absolutely. When you look at the total market and how it's moved, we have lost market share. I would say the biggest part of that is because of the big horses we were riding are struggling in the market a little bit, but that is what it is. And, as I mentioned earlier, not a broad enough product line.

No, we're committed to the business and the reason is Jim, it's just another flavor of our core connectivity business. I think if this was something totally different that we did, we might think about it differently, but we ought to be able to do a better job of leveraging our scale and leveraging our resources in this business to compete. So, I would say the only good news about it is, as bad as we feel about our performance right now it's all upside in the way and all we have to go and make it happen.

That's not going to happen overnight, but, like we did when we really got broke back into it after being out of it years ago, we feel like we know how to do it. And, we've got much more focus on the business in the last six months from a structural point of view. So, we feel good in terms of the road map and things like that, but we've got to get them into the customer and sustain them in the customer. I think that's the key in this business, you've got to be broad based, similar to the way we are in auto, we are on every car. So, we ride the benefits of that. We need to be broader-based in this business. I will let Terrence answer the SubCom question.

Yes, Jim, on SubCom when you look at it like you mentioned or I mentioned on the call, we were just awarded and it got funded. The Singapore to Japan contract, that really firms up our current year number and that will roll over into next year. We are also completing some projects in the Gulf, currently. But, what's nice right now is the $600 million to $700 million for this year will put you at about $160 million of revenue for the next couple of quarters.

When you look at next year, right now, our expectation based upon the number of projects we are working on that are in Asia, around Africa, also some connectivity to South America, I would say right now we would still be in the $600 million to $700 million range for next year. But, the opportunities are still driven around hooking up the emerging markets, the need for broadband everywhere and, in that regard, we see a good stable level of mount both for this year and next year.

Great, thank you. And, again, congratulations on a difficult Japan situation, you guys have done well working through.

Thank you, Jim.

We have a question from the line of Wamsi Mohan with Bank of America. Please go ahead.

Hi, thank you, good morning . Can you talk a little bit about the process that you are going through to estimate the Japan impact? So, how far down the supply-chain do have visibility and what products are you hearing that are causing some of the auto production

Sure. As you can imagine, we have a pretty extensive crisis management process around this. The big part of it based with our leadership team in Japan, which is a very seasoned leadership. So, we, every other day literally, between our automotive and our CIS businesses, because that's where this impact is, we get a read from our team in Japan on what they're seeing.

And, I'd say there is really three big parts to it, there is our end customers and are they going to be able to ship products, which is where I would say the part that not that any of this is easy, but to get our arms around, because customer a or customer b says, we're not going back to full production until such and such, or this plant is closed for the next three weeks we know how much we are scheduled to ship them. So, that's a big part of this.

The second piece is our own supply-chain, which the good news is we have been very fortunate there as well, that it is not too disruptive. We did have some suppliers that were, unfortunately, knocked out and we did have some single source parts, but that is a pretty small part of that I would say. Of our $225 million, it is single digit percent of that.

And, the third piece, which is the hardest to really get our arms around, and, as I've talked to other CEOs, it is the hardest time they are having is the extended supply-chain. So, it's the supplier who supplies to another supplier, who supply to one of our customers. We may not have a problem delivering a part to them, but two levels down in their supply-chain, they might have an issue, and the trickiest part is there's always inventory in the channel, so we're only a month into this approximately, there's inventory to cover that. So, I think we all feel like we don't really know what we don't know .

We've put a number on that based on the best information that we have and that's how we come up to this $225 million, I think it's fluid for sure, Wamsi, we hope it's better than that. It could be worse than that. I would say, candidly, the impact on order rates isn't that bad yet, but we also know from what our customers are saying, it's going to probably get worse before it gets better.

So, it is elusive. This is our best way and then the way we sort of take a step back, take a big picture, do a sanity check around it is we do plus or minus $75 million to $100 million a month in Japan. So, that seems outlandish that we could have a two-month disruption over the next six months for all these customers that we serve in Japan when you consider the power outages and everything else, no. That doesn't seem that crazy to think about it that way, so that is really how we try to come into a number that we think is reasonable, that is not wildly optimistic or wildly conservative. Time will

Okay, thanks for the candid assessment. I appreciate that. And, then what sort of dollar content assumptions are you making for Japan and outside Japan? And, lastly, off the $0.09 and $0.14 hit, can you quantify at an EPS level, how much of that is auto related versus non-auto related?

Yes, Wamsi, when you look at it certainly as you know, our content for region is very different. So, when you look at the content per vehicle, we did tell you we were going to be impacted about 3 million vehicles, the bulk of that in Japan, the minor part outside of Japan based upon the customer feedback Tom mentioned. So, that is built up based upon an OEM-based view of our content in their vehicles, so it is done by program.

When you look at the auto element versus the non-auto element, right now, we do not expect anything, any impact to Japan on our network solutions segment. So, it is in automotive and our CIS business and when you look at that, of the $220 million we quoted, about 65% of that will be in our automotive business and the remainder will be in the CIS business.

And, Terrence, is it the same on EPS basis?

Correct.

Okay, thank you so much.

Thanks, Wamsi.

We have a question from the line of Amitabh Passi with UBS. Please go ahead

Hi, thank you. Sorry guys, not to harp on this, but still trying to understand the dynamics in your CIS segment. I understand the weakness in consumer, yet it's about 15% of segment sales and I am surprised to see a 300 basis point negative impact of margins quarter-over-quarter. So, I was hoping you could just help us get some incremental color on just what's driving this or what appears to be sort of a disproportionate impact to your margins?

When you look at it, Amitabh, you have to look at we did expect our margin in CIS to be down as Tom mentioned, and, really, when you look at it is, when we were coming out and we came into the year, we were ramping and expected of faster increase in both consumer and Datacom than what we have been experiencing. Those are markets that are impacted by metals, there are also markets where you do have price erosion, so, right now, you are getting that impact magnified in the margin until the volume as well as some of the pricing actions come into play.

So, really what is happening is we did expect this, we do expect the CIS business exiting quarter four to be around 14%, but, really, what you have is we ramp for a more optimistic picture that is taking slower to come through and then certainly the consumer element, Tom added a lot of color to already, which also creates some pressure.

Okay, thanks. And, then just as my follow-up. It's interesting is if I adjust for the impact of Japan, it seems like you actually raised full year guidance, maybe just additional color in terms of what you think the drivers are positively impacting your full year guidance net of Japan?

Yes, I'd say if you go actually and look at one of these bridges that we talked to over there, a little bit stronger volume in other markets, probably a little higher metals than three or four months ago. And, a little bit of a benefit from exchange rate, so when you net it all out, yes, I think we say $0.14 down from Japan and our midpoint is off $0.11, so slightly better, yes, you're right.

Okay, thank you.

We have a question from the line of Steve O'Brien with JPMorgan. Please go ahead.

Hi, thanks. Could I get a little bit more elaboration on the contribution margin assuming, assumed in the reduction in Japan revenues? Are there additional expenses that related to the crisis management actions that are included in the EPS impact? Things above and beyond just lost volumes?

No, there isn't any additional cost like that. I think the simplest way to think about it, Steve, is our margin right now is roughly 30%, 30%, 31%, so you are going to at least have that. We're not really taking very much variable cost out of these plants in Japan, so the people are still there for a full week, not a partial week for a lot of reasons, right. And, because we think the short term, we want to be ready to produce. So, if you had a more of a sustained downturn in a business, you'd adjust your labor costs quickly and all your variable costs quickly.

So, this assumes more than normal inefficiencies, we think that's going to be short-term, but that is why you would see a flow through, I think what you're basically saying is why isn't it just 30%, 33% something like that, your average flow through, because were not taking any other costs out.

Great, I appreciate that Tom. And, just a quick point of clarification, Terrence, you mentioned the $75 million in patents hold to ADC are not included in fiscal Q3 cash flow. Are they included in that overall fiscal 2011 full-year cash flow?

No, they are not. That will not be -- we will not treat that is free cash flow. So, when you look at neither in quarter three or in quarter four, so the $1.3 billion I guided and we mentioned does not include that $75 million.

Great, thanks for that.

I'm sorry, we have a question from the line of Sherri Scribner with Deutsche Bank. Please go ahead.

Hi, thank you. I wanted to ask a little bit about the operating margins in the transportation segment . They were very good this quarter and I'm wondering if that's all related to the higher volumes or if there is something else in that number? And, then, with the declines you are expecting in that market, what directionally do you see -- clearly I think those margins go down, but, directionally, does it go back to sort of the 10% level or lower than that or just wanted to get some detail

Hi, Sherri, this is Tom. This team has done a great job, did a great job managing through the downturn, and as you know, we're very aggressive getting our capacity in that business in order probably a little faster than we otherwise would've without that downturn, so that helped a lot.

So, we do believe this is kind of the right level of margin and we will try to improve it, of course. It is coming off a little bit in the third quarter because of the Japan impact, again you're taking $100 million of automotive sales out, and, in there, we also have aerospace, defense, marine business which is our highest margin business in the Company and they are performing well, in addition. So, you will see a little dip in -- you will see some dip in transportation margin in Q3 and then we would expect that begin to recover and move back up again in Q4.

Okay, so these levels are sustainable?

Correct.

After the step? And, then just to clarify for the -- I think in past you expected global vehicle production to be about 76 million and I think you are taking 3 million out of that, so should we think about global for the year, global production for the year being about 73 million, is that the way to think about it?

You look at global vehicle production, when you look at it in the second half of the year, we do see that the second half will come down by the 3 million vehicles. I would say people have restated the first six months of vehicle production up a little bit, Sherri, so it does get a little bit confusing . But, when you look at it, it's right now going to be around 75 million vehicles for the year is what the experts say on our fiscal year basis. But, some of the clumsiness with the math is they increase the first and second quarter by about 1 million units

Okay, great thank you.

Thank you.

We have a question from the line of William Stein with Credit Suisse. Please go ahead.

Thanks. First, just a reminder or clarification, can you just to level set models again, can you remind us what the long-term operating model is of the Company for the mantra on operating margins at revenue?

Sure. As you know, when we went into the downturn, we had our boat 12 at 12 goal, the good news was we really got that to about 14%, a little bit over the $12 billion level and then kind of reset it 15% at $14 billion of revenue, excluding ADC. Because ADC is going to have a margin rate drag on it, as you know, because we picked that business up at mid-single digits. We will go out at the end of this year we expect to be in double digits and then by the end of next be closing in on our average company margin.

So, for the non-ADC piece of the business, we still believe, even though metals are a little higher, quite higher than when we set this target that this is still a business that we should be able to get to the 15% margin range in the $14 billion, non-ADC business range. So, a little room to improve in the margin.

Great. And, then, one thing that we have not heard you talk about as it relates to Japan and in particular in light of the strong bookings, is an effort to secure supply. You can imagine that some OEM's might place orders for parts on the worry that they might not get supply. Have you contemplated that in your guidance, have you seen any of it explicitly or do you suspect it of happening and how do you expect that the play out over the next quarter two?

In other words, a little bubble?

Hoarding component.

Like an ordering bubble I think, Will, is what you are talking about? I'd say we see a little bit of that right now, but not really significant. I think $10 million, $20 million of a little extra ordering. We are watching for that because I think we're certainly mindful that it wouldn't be unusual for people to say I'm going to order more just in case, so we see a little bit of that, but we have not seen a lot of that right now.

And, just one final one if I can. Can you talk about your appetite for additional M&A as you digest the ADCT deal?

We think there's a number of areas where we could strengthen the Company through M&A. We have a fairly robust pipeline. We have been building this for several years after not being in that business so to speak for a long time. And, last year, we made a couple of, in addition to the big one in ADC, we made a couple of small technology acquisitions that have really strengthened our fiber connectivity capability. So, we're always on the lookout for that. I think the ADC types are going to be few and far between, primarily because there are just not that many out there like that.

So, I think our priorities will be to number one, add technology through bolt-ons and then where can we had product lines that we don't have in some of our -- we've talked in the past around harsh environment, industrial energy types of businesses. So, we clearly think that, given our cash flow, that is a good way to build value in the business if we can find the right opportunities. We passed a lot more than we've decided to do, because it's got to fit our value proposition and, fundamentally, we feel that there's an awful lot of opportunity to improve this Company organically, both by organic growth through the broad range of technology and product lines we already have, as well as continuing through the P&L. So, it's going to be in our mix for sure, Will. I guess that's the way I would say it, but nothing imminent right now of any size.

Okay, great. Congrats, thanks.

Thank you.

Operator, I think we have time for one more call if there's anymore.

Okay, we do have one more. We have a question from the line of Amitabh Passi with UBS. Please go ahead.

Thank you. I just had a follow-up question. Within your service provider sub segment of network solutions, can you just give us an update of your pipeline for incremental fiber to DX opportunities? We've heard about NBN, I think you've mentioned Telnext, and we have also heard [Rumley's] and Telefonica might be looking to do something more. Just an update on what you're seeing globally and where you think we might see incremental contracts coming through?

It's hard to get specific on things that haven't happened for obvious reasons, because the customers don't really want us to talk about them yet. But, I think we're pretty bullish on the pipeline, a lot of activity. I've been out over the last couple months to a couple of the really big customers, and when you just look at the data that's being demanded, now that everybody is getting tablets in SmartPhones, it's taxing the system and while a lot of it is wireless broadband, you need quite a wired infrastructure, fiber infrastructure, to support that.

So, we saw that our networks businesses were up 20% year-over-year and our telecom, non-ADC portion of that, just run apples to apples because I think that is the best indicator, was up 30%. Our last year wasn't a robust year, but the spending is increasing and we see a lot of activity in Asia-Pac like NBN, a couple of other big ones that RFPs are in the works down that way and we see a lot of activity in Europe. Both those areas have much less fiber in the network than the US does. Although we expect activity to be picking up again in the US, so that growth is really driven without much US growth in it, so we think it's coming into a good cycle for this business.

Tom, just any thoughts on China? Do think that's an opportunity or do think the market is still too tough?

It's an opportunity that's tough. The way that I would put it. We do have a decent beachhead now through the acquisition, but infrastructure in the big emerging markets is probably amongst the toughest businesses. But, we've good products, we have local products and combining ADC and ourselves gives us a more robust product line there. So, that's part of our growth assumption .

We're not counting on extraordinary success there to drive this business. We're counting on being there and capitalizing on high market growth, being a player, but we don't really expect to have anywhere near the kind position we do in Europe or the US, or Latin America. Because it's a high-growth, it will

Thank you.

Thank you very much, everyone.

Thanks for joining our call. Please feel free to call the IR department with any questions you might have during the day. Thank you

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