泰科電子 (TEL) 2016 Q1 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to TE Connectivity first-quarter 2016 earnings release call.

(Operator Instructions)

As a reminder, today's conference call is being recorded. I would now like to turn the conference over to Sujal Shah, Vice President of Investor Relations. Please go ahead.

Good morning and thank you for joining our conference call to discuss TE Connectivity's first-quarter results. With me today are Chairman and Chief Executive Officer Tom Lynch, President Terrence Curtin, and Chief Financial Officer Bob Hau.

During the course of this call we will be providing certain forward-looking information. We ask you to review the forward-looking cautionary statements included in today's press release.

In addition, we will use certain non-GAAP measures in our discussion this morning. We ask you to review the sections of our press release and 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 participants on the Q&A portion of today's call, I would like to remind everyone to limit themselves to one 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 opening comments.

Thanks for joining us today. Here are the key take-aways from today's call. We've begun FY16 with a quarter of solid execution, delivering $0.84 in adjusted EPS, $0.08 above the high end of guidance, with sales slightly above our mid point. This was driven by strong performance in our transportation segment and SubCom business in combination with tight cost management in light of the macro environment.

Excluding the impact of currency exchange rates, Q1 adjusted EPS was flat year over year, and adjusted operating margins of 15.7% were ahead of expectations. For the full-year 2016, we are reiterating our adjusted EPS guidance of $4. This is 11% year-over-year growth and 15% growth in constant currency.

Relative to our view last quarter, the transportation segment is a little stronger, with global auto production expectations improving. In industrial our direct business with OEMs developed as expected and appears to be stabilizing, but sales through our distribution channel were weaker than expected and the recovery is taking longer than anticipated. The oil and gas market remains very weak with derivative effects impacting some other industrial markets.

The mid point of our annual guidance assumes 2% global auto production growth in our fiscal year. We're also assuming sequential improvements in industrial sales and orders in the second quarter and into the second half.

For the full year in communications, we assumed double-digit growth in SubCom, second half growth in appliances and continued declines in data and devices. By region, we assume that the overall US and European economies continue to grow slowly and China returns to growth in our markets in the second half.

We continue to take a balanced approach with our capital strategy and over time expect to return approximately two-thirds of our free cash flow to shareholders through dividends and buybacks, with one-third of free cash being used for acquisitions. And we'll talk more about this later in the call.

We are very pleased with the performance of the businesses we acquired last year and will continue to look for acquisition opportunities that broaden our ability to address harsh environment applications and provide integrated solutions to our customers. We believe that integration is another emerging secular trend for our business and we are well-positioned to capitalize with our broad portfolio of products.

In sensors, our unmatched presence across virtually every industry, coupled with the broad technology and product portfolio we acquired, is enabling us to expand our design win pipeline across market verticals and provide integrated solutions in certain applications. In medical, we have increased our presence in the high-growth, minimally invasive markets, and are well positioned to provide integrated solutions to our customers that incorporate our connectors, sensors, fine wire technology and material science know-how.

While we can't control the macro environment and inevitable economic cycles, we have positioned TE around harsh environment applications and continue to benefit directly from the secular trends of electronic content growth. We believe TE is uniquely positioned to provide highly engineered solutions that integrate connectors, sensors and other technologies to improve reliability, lower cost, and increase performance, making the Company an increasingly valued partner to our customers. And we have secured several key integrated solutions design wins, particularly with major auto OEMs, over the last several months to prove out this point.

Please turn to slide 3 for a summary of Q1 results. While we continue to have the backdrop of a challenging macro environment, we generated adjusted EPS above the high end of guidance, with sales slightly above the midpoint of guidance. Sales of $2.8 billion were down 7% year over year but down only 1% in constant currency. Adjusted EPS was down 6% year over year but flat in constant currency.

Performance above guidance in the quarter was driven by strength in our transportation segment and higher sales in SubCom as a key program moved to completion earlier than expected. This, coupled with tight cost control, more than offset industrial being a little weaker than expected in the quarter.

We generated adjusted operating margins of 15.7% in Q1 which were ahead of expectation, and our adjusted EBITDA margins were 21%. During the quarter we returned $1.4 billion to shareholders including $1.3 billion in share buybacks.

The Board of Directors also approved a recommendation to raise our dividend by 12% to an annual rate of $1.48 per share. We expect this to be approved by shareholders in March and be effective in June. We also paid $127 million in dividends in the quarter. In addition, we returned approximately $1.3 billion of cash to shareholders through the share buybacks.

While down year over year due primarily to weakness in China, our transportation segment sales were above expectation, with better than expected demand in China. China was weak but it was not as weak as we thought. In the industrial segment, our direct business with OEMs performed about as expected but we did see lower sales through the distribution channel.

Overall, we continue to perform well in harsh environment applications, with last year's acquisitions in sensors and medical gaining momentum. And during the quarter we announced the sale of our circuit protection business which is on track to close later this quarter.

Before we get into the segment updates, I'd like to provide a brief insight into order patterns which will help provide a baseline for our results and expectations. Please turn to slide 4.

Organic orders were down 3% from the prior year but were better than our expectation 90 days ago. Orders were up 3% sequentially, excluding SubCom, and our book-to-bill was 1.04. China orders were up 11% sequentially on an organic basis and better than expected. These data points are positive indicators for our expectations of second-half sales growth.

One area that doesn't remain weak is the distribution channel where our expectations of sales and orders recovery has pushed out slightly versus our prior view. Distribution accounts for about 15% of our total sales.

Transportation orders improved 7% sequentially, reflecting incremental growth in global auto production expectations. During the quarter we saw our industrial orders stabilize and grow slightly sequentially, with direct orders improving in line with expectations and weakness in the channel that I previously mentioned. Communications orders ex SubCom declined 9% sequentially driven by previously announced product exits and weakness in the distribution channel.

To provide a little additional color on China, while both orders and sales were down year over year in aggregate in Q1, we are seeing improvement in auto production and saw year-over-year organic growth in orders in transportation. We continue to see China weakness in the industrial and communications segments but are expecting growth in the second half as inventories come more in balance. Excluding SubCom, our book-to-bill ratio is 1.04 in Q1 with all segments book-to-bill exceeding 1.

With that backdrop I'll now turn it over to Terrence to cover each of our segments in more detail.

Thanks, Tom. And good morning, everyone. If you could please turn to slide 5 and we'll start with transportation solutions. Sales grew 1% organically in the quarter, above our guidance expectations due to China sales being stronger than we anticipated. Overall segment organic growth of 1% was driven by automotive and sensors.

Our auto sales organic growth of 1% in the quarter was driven by Europe growing 6% and North America growth of 3%, offsetting the expected reductions in China that Tom talked about. With the orders that we experienced, along with production schedules, we expect China to return to growth in the second quarter, reflecting the positive demand impacts from the government tax incentives that are driving increased production levels.

For FY16, we now expect global auto production to be up 2% to just under 88 million vehicles with China production up 6% compared to 2015. This compares favorably to our view last quarter when we expected flat global auto production, with China production growth of only 2%. We continue to be confident that our auto business can grow well ahead of production as it's included in our annual guidance, and this is driven by electronic content growth and a rich pipeline of platform ramps from design wins generated over the past several years.

As expected, our commercial transportation business was down year over year driven by a weak global construction and agriculture market and weakness in the North America heavy truck area. While our sales declined versus last year, our organic orders were up 10% sequentially as we're seeing signs of this business stabilizing. And we expect to be up to flat low single digits on an organic basis for the year.

Turning to sensors, our business continued to show strong momentum in the quarter in both sales and design wins. Aligned with our acquisition rationale, we are using the existing TE go-to-market teams to take new products and system level solutions to our customers. This results in new sensor program awards across multiple market verticals.

TE is uniquely positioned with the world's broadest portfolio of connector and sensor solutions, and we have recently been awarded design wins in the automotive space that integrate multiple components to provide a complete solution to our customers. In this segment adjusted operating income was $280 million in the first quarter. This was down year over year due to currency, a change in product mix, and our continuous investment for growth in automotive and sensors businesses. Adjusted operating margins came in higher than we expected and we anticipate the second-half margin to be at 20% or above.

Please, if you could turn to page 6 to discuss our industrial solutions segment. Aligned with our expectation, revenue in the segment declined 6% organically year over year in the first quarter. As Tom mentioned, we are being impacted by weakness in the distribution channel which is almost 30% of the segment's sales organically.

Distribution sales were down 6% organically in the quarter as we see broad-based supply chain corrections occurring that we highlighted last quarter. Our direct sales to OEMs are improving in line with our expectations and we saw our OEM orders improve sequentially by nearly 3%, while orders through the channel partners remained flat sequentially. We currently expect that our distribution partners will continue to work through the second quarter to get in line with OEM demand.

In addition to the distribution channel, we continue to be impacted by the oil and gas market. As you can see on the slide we broke this out separately this quarter and it shows the 44% organic reduction in sales year over year in this market and the impact that's having on the segment.

With the weakness in the oil and gas market, our business is now running at approximately $30 million per quarter, down from approximately $60 million per quarter a year ago. We have seen order rates stabilize around the $30 million level and we expect a more favorable year-over-year compare in the second half.

I also want to highlight that the low oil and gas prices are also having some derivative effect in other areas of the industrial segment, impacting sales in our industrial equipment business in areas like factory equipment and rail and also in helicopter demand which affects our aerospace business. These derivative effects are reflected in our guidance and our results.

In the commercial, aerospace and defense business our momentum remains strong, with a slight year-over-year decline driven by the defense business due to program timing. We remain very well positioned with our program wins in this space and expect to benefit from growth in the commercial aerospace and as the defense market continues to improve.

Our energy business grew 4% organically, with strength in Europe and the Americas more than offsetting softness in China. From an adjusted operating income perspective, it was $78 million in the first quarter, down year over year, as expected, due to the impact of currency, declines in our higher-margin oil and gas business, and 6% organic decline in the channel. If you exclude the oil and gas business and FX impacts our operating margins remain constant year over year, reflecting the benefit of our TEOA program, as well as cost management.

If you could turn to slide 7, please, so I can talk about communication solutions. In the first quarter, the segment revenue of $617 million was down 6% and 3% organically, as expected. Our SubCom business saw strong year-over-year growth as we successfully completed the America-Europe Connect program earlier than our original plan. We now expect SubCom to grow low double digits for the full year, which is slightly better than our expectations 90 days ago.

Our data and devices and appliance businesses were impacted by the slowing in China, as well as the supply chain adjustments by our distribution partners, similar that I talked about in industrial. We expect this to be largely behind us as we head into the second half of the year. And just to remind you, data and devices growth is also impacted by the product exits that we initiated late in 2015 as part of our repositioning effort.

From a margin perspective, adjusted operating margins expanded 380 basis points year over year, which was above expectations, driven by the early completion of the program in SubCom that we highlighted. Now let me turn it over to Bob who will cover the financials.

Thanks, Terrence. And good morning, everyone. Please turn to slide 8 where I'll provide more details on earnings. Our adjusted operating income was $444 million, down 5% in constant currency due to investments in transportation, impacts of oil and gas weakness, and the distribution inventory corrections impacting our industrial segment that Terrence covered. Including $30 million of foreign currency headwinds, operating income was down 11% from the prior year.

GAAP operating income was $398 million and included $6 million of acquisition related charges as well as $40 million of restructuring and other charges related to data and devices product exits, elimination of corporate stranded costs from the BNS divestiture, and general cost reductions. Our adjusted EPS was $0.84 for the quarter, down $0.05 from the prior year, with reduced volume from higher margin products and negative impacts from foreign currency exchange rates, offsetting incremental benefits from the share buyback.

Excluding the $0.05 impact from foreign currency, adjusted EPS was flat to the prior year. GAAP EPS was $0.83 for the quarter and included acquisition-related charges of $0.01, restructuring and other charges of $0.07, and $0.07 from tax-related income. I now expect approximately $85 million of restructuring charges for the full year of 2016, a $10 million increase from our prior guidance 90 days ago.

Please turn to slide 9. While we remain in a challenging environment, the progress we've made with TEOA on productivity initiatives enables the business to demonstrate resiliency, as reflected in our margins. Our adjusted gross margin in the quarter was 33.4%. While this was down from last year due to lower sales on higher margin products, it's up 90 basis points sequentially from Q4.

As Terrence discussed in the industrial section, we're seeing softness in some higher-margin businesses like oil and gas and lower sales to the distribution channel. Adjusted operating margins declined 70 basis points driven by lower volume and product mix but benefiting from the early completion of the SubCom program in the quarter.

Total operating expenses were $502 million in the quarter, down 8% from the prior year. We continue to tightly manage discretionary spending but are also continuing to invest in our harsh businesses. In the quarter cash from continuing operations was $367 million and our free cash flow was $237 million, up from prior year levels due to lower working capital on reduced revenue and timing of SubCom payments.

We continue to have a balanced capital allocation strategy. In Q1 we returned $1.4 billion to shareholders including $1.3 billion in buybacks. In the quarter we bought back nearly 21 million shares, executing against our commitment of returning the proceeds in the Broadband Networks divestiture.

We're also introducing a chart on EBITDA margins, which better shows the profitability performance of our businesses, including acquisitions. EBITDA margins in Q1 were 21% and shows our margin resiliency despite lower sales levels. We continue to be pleased with the operating performance of our business especially in light of the challenging macro backdrop.

Also, you may have seen in the 8-K filed yesterday Tyco International, on be behalf of TE Connectivity, has entered into an agreement with the Internal Revenue Service to resolve all disputes related to the previously disclosed intercompany debt issues. The resolution would result in a total cash payment to the IRS from TE Connectivity of between $147 million and $163 million, which includes all interest and penalties.

We are pleased with the proposed settlement and look forward to having this behind us in the near future. Of course we've also added a balance sheet and cash flow summary in the appendix for additional details.

Now I'll turn it back to Tom.

Thanks, Bob. Please turn to slide 10 and I will cover Q2 guidance at a high level with additional details provided in the slide deck. We expect Q2 revenue of $2.88 billion to $3.08 billion, down 3% or 1% organically and adjusted EPS of $0.84 to $0.92, down approximately 3% year over year at the midpoint but flat in constant currency.

Versus our view last quarter, we expect transportation to be a bit stronger, industrial to be a bit weaker, and communications to be impacted by the early completion of the SubCom program we discussed earlier. Most of that was in Q2 when we guided last time.

For the full year we expect revenue of $12.3 billion at the midpoint, up 1% versus the prior year and reflecting 4% organic growth at the midpoint. We are reducing top line by about $100 million reflecting the sale of our circuit protection business that we expect to complete this quarter. Our adjusted EPS guidance remains at $4 and represents year-over-year growth of 11% at midpoint.

On a constant currency basis revenue is expected to grow over 3% and adjusted EPS is expected to grow by 15% year over year. Versus our prior view, transportation is expected to have higher growth, industrial a little weaker, and communications is weaker, factoring the impact of the sale of the circuit protection business. I think you've heard a constant theme here -- transportation a little better, industrial a little weaker -- but overall no big change from the prior guidance.

Our full-year outlook is based on the following market and regional assumptions. In transportation we expect mid single-digit actual and high single-digit organic growth. We're assuming that global auto production is up 2% year over year, which is an improvement from our prior view of flat production. We're anticipating China production to grow 6% year over year.

We expect another year of strong growth in our sensors business. In industrial, we are assuming flat actual and low single-digit organic growth. We have seen orders stabilize in some industrial end markets and assume inventories come into balance by the end of Q2, ending the negative supply chain evidence effect on our business.

We continue to assume a weak oil and gas market and we'll continue to see the signs of the negative impact in other adjacent markets in the industrial space, which is also factored into our guidance. In communications, we assume high single-digit actual and low single-digit organic decline, with growth in SubCom and appliances being more than offset by product exits and the sale of the circuit protection business in data and devices.

By region we assume Europe and the US to continue to improve with China markets rebounding in the second half. Outside of auto, China markets are as expected 90 days ago. Our guidance does assume a 53rd week and current exchange rates. As the year progresses we have much less of a headwind from FX translation and an increased earnings tail wind from our share repurchase program.

We remain positive on our outlook and have several levers to drive growth in a very challenging macro environment. As a result of the transformation of our portfolio and increased focus on harsh applications, we are well-positioned with differentiated solutions for our customers.

The secular trend of content growth is increasingly apparent in our served markets and our ability to produce integrated solutions that solve system level challenges for our customers will enable TE to continue to become an even more valuable strategic partner for our customers in the future. These factors, combined with our TEOA initiatives and capital strategy, are expected to drive consistent double-digit earnings growth.

Now, Sujal, let's open it up for questions.

Thank you, Tom. Cynthia, could you give the instructions for Q&A session?

(Operator Instructions)

And our first question is going to come from the line of Amit Daryanani with RBC Capital Markets. Your line is open.

Thanks. Good morning, guys. Just to start with, on the industrial segment, could you just talk about the margin ramp expectations as you go forward after the December quarter numbers? And is there incremental cost-cutting initiatives that you guys are thinking about to help drive these margins potentially towards the mid teen to corporate averages?

Amit, this is Bob. Good morning. We do have some incremental restructuring, as I mentioned. Our prior guidance included $75 million of restructuring. We've now raised that to $85 million. In the first quarter we spent $35 million. The actions that we did have planned for the year, we pulled the trigger a little bit faster, so we'll see some benefit of that in the latter part of the year, as well as the increased spending. That's not particularly directed at industrial. It's more directed at data and devices where we got the product exits.

In corporate spending overall, which impacts all of our segments from the BNS stranded costs, there is some additional activity and additional benefit in oil and gas that will obviously benefit industrial. Overall, as we see volume recover, and in particular as we work through the final implications of the distribution inventory channel recovery in the second half of the year, you'll see margins lift. Obviously at 11% in the current quarter with revenue down, and in particular oil and gas high margin, in distribution channel very high margin, we're seeing a negative impact that improves into the second half of the year.

Got it. And then just as a follow-up, the March quarter guide, I apologize if I missed this, but you're looking at sales to be up rather nicely sequentially but EPS guide, or I should say operating margins, are implied to be down. Is there a gross margin dynamic that's going on sequentially or is OpEx going to ramp up? And, if so, can you just talk about why and how much?

There is a number of moving pieces as you move from Q1 to Q2. Probably the biggest one -- and Tom and Terrence alluded to this a little bit, and I think I made a brief comment on it in my opening comments -- part of the benefit in Q1 was the timing of the completion of the SubCom program that's a very high margin. As you wrap up a SubCom program you typically report very good margins on that last gasp spending there. That is pure timing that was completed earlier. So, we saw the benefit in Q1. That pulls directly out of Q2 and to some extent Q3.

Next we'll go to the line of Craig Hettenbach with Morgan Stanley.

Yes, thanks. A question for Tom. The opportunity in auto seems intriguing in terms of you're talking about integrated product. Just want to get some background there in terms of the technology pieces you have to offer, really, as you interact with customers and suppliers, how you see the market evolving there and how you can play into that.

Of course, in our core connector business we have an incredible range of products. We're in every facet of the vehicle. And that's supported by almost 2,000 engineers facing the customer. So, you have this tremendous presence at every customer with a wide range of connectivity products.

But we also, of course, now have sensors and a broad range of sensor technology. We have sealing and protecting products. We have relays. We've been doing integration on a very small scale for many years and, with the advent of the sensors in the product line, the ability to go into certain applications -- not every application but the more complex applications -- and pull three or four different products together which might have been handled by three or four suppliers before, and integrate them into a sub-system. It takes out cost, space, weight, and, from a customer's perspective, it's one supplier to deal with.

We've been doing this in the past but the addition of sensors into the product line has really opened up much more for us and we've had some very nice design-in wins, I mean significant design-in wins, in the last six months. They won't start shipping probably for about a year and a half to two years. It's this broad range of products and all these engineers we have sitting in front of the customer.

And we know the architectures almost as well as our customers. We've been doing this for so long. When you have that many engineers you have this deep knowledge. And they share with us what they're trying to accomplish. They're not just asking us for a spec. They're telling us this is what we're trying to do and that really opens it up for us to bring in a solution.

Got it. Thanks for that. And just as a follow-up, certainly we've seen a lot of volatility and pressure in the equity markets. I'm just curious, as you look at your M&A pipeline and on the private side, are you seeing much change? Do you think there could be opportunities? Any thoughts on that for M&A.

As you know, our strategy is around harsh environment connectivity and sensors. We have a robust pipeline that's based on our product strategy. The first part of your question, that's in a sense what drives our acquisition strategy. We're not just buying parts. We want there to be customer synergy, as well. So, yes, we expect -- last year we acquired, closed acquisitions worth about $700 million in revenue.

Our goal is to continue to plug in technology and products like we've been doing because, with all this engineering presence and all the sales and marketing presence in front of the customer, just think of us adding more tools into our tool bag and that's what customers want. It's a pretty powerful model we have. And, as you know, we're selective. We don't do that many. We look hard. We make sure that there is a good fit. But we have a pretty active pipeline. Terrence, do you want to add to that?

No, I think, Tom, you handled it well. When you look at last year, and we did do four last year, certainly the big ones were around measurement and sensors, as Tom talked about. Also, in the medical space, that is another example of a harsh environment application, leveraging the capabilities that Tom talked about to your first question, Craig.

So, I think you're going to continue to see things like that. And I think when you think about the pipeline momentum we have we feel very good about it. I don't think there's anything that is meaningfully changed, even with all the macro backdrop, as we look at the pipeline to answer one element of your question.

Got it. I appreciate all the color. Thanks.

Our next question comes from the line of Wamsi Mohan with Bank of America. Your line is open.

Thank you. Good morning. Your restructuring charges incrementally are going up $10 million over here but is that enough given that the near-term weakness in data and devices is really pronounced? Organic revenues were down close to [$90 million]. It's the largest decline in sheer dollar amount relative to much larger segments. I'm curious how you see this progressing especially given that you're also divesting the CPD business. And I have a follow-up.

The $85 million, as I mentioned, is a small increase. We did spend quite a bit of restructuring last year, particularly at data and devices, to proactively get at some of the costs. As we execute against those product exits that we initiated in the first part of 2015, we took a lot of restructuring charges and started actions then.

As we continue to execute against those exits and the revenue declines, that's what's driving some of the incremental spend. We got out in front of it early on in 2015 as we announced those exits and we continue to take out costs, where appropriate.

Okay. Thanks. That's helpful. As my follow-up, what's the margin trajectory that we should assume ex-SubCom within data and devices? Should we expecting some of these past actions to start to bear fruit from the margin front here through the next couple of quarters? I'm assuming most of the operating margin improvement in that segment came from better SubCom performance in this quarter.

Hi, Wamsi, this is Tom. I would say you'll see it next year. The market outlook is pretty weak and we're dropping -- we're getting out of a lot of revenue. Most of it is very low margin.

But by the time we get through this year's restructuring and the product exit, we expect that we'll begin to build margin momentum because, as you've heard us say before, about two-thirds of the business is very good, solid business. It's the core kind of highly engineered products that we do. So, next year. I wouldn't look for much this year.

Thanks, Tom.

Wamsi, just to remind you, we've got product exits or the divestiture of the circuit protection business that's part of data and devices that will impact us in the second half of the year. We expect to complete that here in the current quarter.

Okay, great. Thank you.

Our next question comes from the line of Matt Sheerin with Stifel. Your line is open.

Thanks and good morning. A question, Tom, on your commentary regarding the distribution inventory correction that looks like it's extending here another quarter. Are you getting a sense that sell-out distribution has stabilized and relatively normal and there's just an inventory build that has to be reduced here? Or are you getting sense that sell-out for distribution is still weak or maybe getting weaker?

I'm going to let Terrence handle that one. He was just with that group.

Hey, Matt. Good morning. A couple of insights. I think when you look at it, one of the things that was weaker, we actually saw the inventory come down as expected with our partners, but sell-through was a little weaker than we expected, which is why we see supply chain correction happening, impacting our channel partners. So, the inventory bring-down in the first quarter on what they had was there but the sell-through was weaker.

What we look at is also the direct order patterns that we see. And what we see with direct order patterns that have turned, that Tom talked about, as well as what we're seeing elsewhere, it does look like it's going to be another quarter or so where we're going to have our partners and expect that sell-through to improve.

When you look at this quarter, we still expect it to be a weak sell-through quarter. I think when you take our segments like industrial, I think what we talked about this quarter we'll expect the same sort of next quarter from the channel element of it. They're still being worked through and sell-through was a little bit worse than we thought.

Okay. Fair enough. And it looks like some of the semiconductor suppliers that have already announced earnings have talked about that inventory correction having played out. They tend to lead by a quarter or so. So, that may be encouraging.

And just as my follow-up, regarding the recent divestitures of BNS and then now the circuit protection business, are there other things here that you're looking at to divest or is that pretty much done, specifically in the data and devices area where it looks like you're pruning down and deselecting revenue? Are there other parts of that business that you could sell off?

No, Matt, you stated it well. It's much more around product line exits now. We feel the portfolio's really strong with the 90% sensors and connectors, 80% harsh. And even within the data and devices piece that I alluded to on the prior question, the products that are in there are very good products, solidly profitable. Circuit protection was more of a standalone business, which was primarily in the consumer space. I'd never say never because the world's always changing but I'd say the heavy lifting is behind us.

Okay. Thanks a lot.

From the line of Mike Wood with Macquarie, your line is open.

Hi, guys. Thanks. It's Ryan filling in for Mike. I just had a question on the destocking that you guys are calling to end this next quarter. What are customers telling you guys that give you confidence that this is happening? And do you have a rough sense of how much destocking took off the overall orders and in particular in the industrial segment?

A couple of things. What our customers are telling us certainly we've seen via their orders with that increase. As Tom highlighted, both in transportation and industrial we saw sequential order increases and that was driven by direct activity.

When it comes into the actual destocking amount, we did think that was around $20 million in the quarter of actual inventory but the sell-through was a little bit worse than we expected, which is why we think it's going to work through in this quarter as we try to look at our channel partners do have to get back to OEM demand. They have to come back into parity at some point.

What I would add to that, Terrence, is our actual orders from the channel partners were flat this quarter and they had been declining for three quarters. It's one data point. And as Terrence said earlier, we've got to see the sell-through pick up. But we feel like, when you look at the direct business, still growing, albeit low growth, that over time the channel will converge with that. We're projecting it will converge into low growth with that based on the trends we're seeing.

Great. And just a quick follow-up, is there any material end market differences or product differences that explain the trend differences between OEM and distribution other than just destocking?

In distribution it's pretty broad based. So, the trends that we've actually seen have been broad based and that's why you see both the impact in the industrial segment and the communications segment. When you look at the direct business, it varies by end market dynamics. So, certainly things like commercial air are very strong, oil and gas weak. But on the channel side it's pretty broad-based.

Thank you.

From the line of Shawn Harrison with Longbow Research, your line is open.

Good morning. I wanted to dig into auto a bit. You guys have always been pretty pragmatic in terms of thinking about production rates and where the market's going. It looks like FY16 will be a little bit better than you initially thought. But are we entering a peakish production environment? The real question is, how long can this strength, can it last, knowing that content is always going to be your friend? But just wondering, are there markets where you're concerned that they could be peaking in 2016?

I'd say, Shawn, a couple different ways to think about it. And you really got to do it almost by region because Europe has still not got quite back to pre financial crisis demand levels. The US, while calendar 2015 was a record level, is still slightly -- the average age of a vehicle is slightly higher than normal. If that would change dramatically might get worried. And, of course, China is naturally slowing down but still going to be a pretty nice growth business, 5% or 6% long term. And if you just look at the emerging markets and how many people are coming into the middle class, the trends show get a nicer place to live and buy a car. So, we think those trends are pretty good.

Auto production last year slowed a little bit from the prior year. This year it's in the 2% range. It feels very hot when you're in the US but globally it's still a little bit below -- the FY16 production rate is a little bit below its historical growth rate. And then on top of that, to your other point, the content growth is just consistent in every part of the vehicle. And we don't see that slowing. And then on top of that, the point I made in the comments about this integration, it doesn't happen overnight but it's real. We are being pulled into dozens of opportunities to do this and this broad product range of ours enables that. There's multiple drivers.

And then, of course, if the push stays on green, which I think it will, even though oil prices are very low right now, the content in a hybrid vehicle or electric vehicle is a multiple of an internal combustion engine. I think the positive drivers far outweigh the negative drivers. There will be cycles but it's not like we've been in a boom cycle. It's been, over the last five years, a little bit higher than normal coming off the prior five years being lower than normal.

Then as a follow-up, I'm struggling with the flat sales in industrial for the year because first half of the year, understanding all the dynamics, you're probably going to be down mid to high single digits year over year, implying you need similar type of growth into the second half. Direct sales within industrial, I think you quoted, was up 3% here in the December quarter. So, there's an implication that we either see some restocking event or some acceleration of true underlying demand in the second half across the entire portfolio. So, I'm trying to dig into whether you expect any restocking in the second half of the year. Or, where do you expect demand to accelerate to even now for flat for the year?

A couple of things, Shawn. I do think you're a little bit high on an organic basis when you take currency out, when you do look at it. We also were impacted in our fourth quarter on the channel effect, as well, so there is a little bit of a favorable compare. But we do expect the overall direct business to be about plus 3%. We'll get some of the anniversary effects.

We do assume that our channel business will get back to parity where it ran last year in the latter half. So, there is a little bit of a restock that happens in quarter 4 due to quarter 4 being very weak that we talked about last fourth quarter. So there is a little bit of that effect that helps you get closer to flat.

We do have comm-air programs that are launching, which is an uptick, as well as some things in medical that are launches due to the medical side and the program wins there. So, there are some things that are a little bit uppers in medical and comm-air that help make it a little bit rich, as well as the distribution channel getting back to a more normalized level, more like it was in the middle of last year than where it was in the quarter 4 time, quarter 1 time, certainly the quarter 2 time that we're in right now.

Thanks a lot. That was great.

From the line of William Stein with SunTrust, your line is open.

Great. Thanks for taking my question. First, I'd like to dig a little bit into the sensors business, in particular in automotive. It sounds like these are integrating functions that might have already existed in the car. Is that a fair way to look at what's happening, and the dynamic in this part of your business may be more of a share gain versus a competitor or standalone sensor competitor in that area? Or is this more new content?

It's a combination, Will. Where we're seeing the most opportunity now is in the powertrain as customers evolve their powertrain, and the ability to integrate in a subsystem -- sensors, connectors, [rounding,] sealing, et cetera. That's where a couple of our more exciting opportunities have been. But where you have larger, more complex content, that's where the biggest opportunities are.

And maybe you can help me also think about your share and your opportunity in that market. I think you have a very substantial share of automotive connectors and a very small share in automotive sensors. Are you seeing any initial effect in sales, not just design wins but actual sales, in that market today? And what do you think's the pace of your share gains over the next several years?

It moves slowly, Will. No, it's not in our sales yet. We're selling. We're selling at a high single-digit growth rate the products we have in sensors, so that is playing out very nicely according to plan. I would say the design rate in some of the applications that we're penetrating is playing out ahead of plan, some of the more rich applications in the auto space. But it will take some time.

But you're right, significant connector share. But, by the way, we feel the opportunity to continue gaining, as we've been, with the new applications we're bringing, and very small sensor share because we didn't really have much of a sensor platform. But now with the acquisition we have pressure, position, humidity, et cetera, things we didn't have much of before. And we're getting design-ins across all of those in the auto space and the industrial transportation space.

If I can squeeze in one clarification -- is the circuit protection revenue included in the March quarter guide? And is it excluded from the full year? How is that working?

We expect that transaction to complete in the latter part of Q2. So, in part of Q2. It is out for the second half of the year, essentially the drive of the reduced guidance on a full-year basis.

Thank you.

From the line of Steven Fox with Cross Research, your line is open.

Just a couple questions on margins. Just looking at off of the base of gross margins you just reported, the 33.4%, you mentioned a bunch of different mix issues going forward -- distribution, SubCom, appliance, et cetera. How does the gross margin get affected as we go through the rest of the fiscal year by all these mix changes coming and going? And then I had a follow-up.

There's always mix issues, both favorable and unfavorable, in the current quarter. We're really seeing a negative mix on oil and gas in the distribution channel in particular, with a positive lift in the SubCom. The SubCom benefit in Q1 is a direct timing out of largely Q2, but also Q3. Oil and gas will continue really through the end of the second quarter when we start getting easier year-over-year compares. And the distribution channel, as Terrence pointed out, we think we've got one more quarter of this inventory correction and lower point of sale to work through. So, you'll see that improve in the second half of the year.

We also see lower FX impacts as we saw significant strengthening of the dollar really start in Q2 of last year. So, that year-over-year impact diminishes. And, of course, you get the benefit of more restructuring savings and lower metal costs into the second half of the year. That helps lift the overall gross margins going forward.

So, it sounds like if you add all those up, that's probably a lot of math to do right now, but you have more tail winds around gross margin than head winds as you get into the second half of the year, even excluding the volume pick up. Is that fair?

Yes.

Okay. And then just a quick follow-up question on the SubCom business. I understand timing had an issue to play here in terms of the margin impact, but if you smoothed out this quarter and last quarter in terms of volumes and then looked to the double-digit growth you're talking about for the full year, where are the margins improving to in SubCom? How much increase is coming through and where are they at versus maybe prior peak levels? Thanks.

What we said on SubCom is it's a $750 million, $800 million range where we're at. We get into the double-digit range. As we see additional volume, if new programs were to come into force, and if that volume were to ramp up, say, to $1 billion, which is really where we peaked in prior years, you start getting up into the Company average, 15%, 16% operating margins.

Great. So, all that's on track once we smooth everything out here.

Yes. Obviously we saw better than that in the first quarter and our full-year guide is in that about $800 million range. So, we'll see double digits. We won't be up to the Company average this year.

Great. Thanks so much.

From the line of Sherri Scribner with Deutsche Bank, your line is open.

Hi, thanks. I just wanted to make sure I understand the operating margin dynamics in the different segments. I think what you said was that transportation, the margins in the second half would improve to 20% to higher for operating margins. Industrial would get better in the second half. And then for the comms business margins get worse in 2Q and 3Q but I think you're implying that they get better in the fourth quarter. I just want to make sure I understood those dynamics.

Essentially you're exactly right, Sherri. On transportation and industrial, very consistent with what we were trying to describe earlier in the call. From a communications solutions segment, I think the way to think about it is if you adjust out the timing benefit of the completion of the SubCom program, we still see improvement on a year-over-year basis. We're in double digits, just north of 10% operating margin. And we'll see a negative impact of that into Q2 but then more into that 10% range in the second half of the year.

Okay. And that's ex-SubCom.

That's including SubCom.

Including SubCom, okay, perfect. And then I was hoping to get some comments, Tom, in terms of the macro environment from you. I think you said that China is about as you had expected 90 days ago but it sounds like most metrics are suggesting China is weaker. So I was hoping you could maybe provide a little more detail and maybe some detail on what you're seeing in emerging markets. Thanks.

Sure. China's our big emerging market by far. We do have business in Latin America and India but China's the big one. China was down, as we said, year over year in revenue. It was up sequentially -- flat in orders, up sequentially in orders, which is a good sign. It came back faster than we thought.

Now, it's one data point. We have to see that continue. But we had the first sequential improvement in orders in a year so that feels like a pretty good sign. We expected that to happen in the second quarter, and happening in the first quarter is encouraging. So, that was a little better.

If you go around the rest of the world, I think the US, in a way, was a little worse because of the industrial in the channel. And oil and gas continues to be down, as Terrence talked quite in detail about the channel. And then Europe continues to be steady, another I think it's six or seven quarters of growth in a row now in Europe. We don't see any signs of that backing off yet. So, versus 90 days ago, the outlook feels slightly better because of this industrial OEM orders increasing sequentially and China orders increasing sequentially.

Of course it's a key quarter for that to continue and to set up. We'll get normal seasonal growth in the second half. We've been seeing our orders trend naturally the way they always do seasonally as we get towards the second half of the year, but we expect them to pick up from the run rate because of the correction, primarily in the channel and secondarily. If China continues where it was in Q1 orders, we'd be in good shape for China for the balance of the year, even if it doesn't raise from there, if it just stays at that level. Terrence, do you want to add to that?

Sherri, just one thing I would like to add and highlight is, when you look at China, China is over $2 billion of revenue for us and [50%] of that is around our automotive business. So, when we talk about our China trends -- and it was a little bit better in our transportation area, like Tom talked about, and certainly we see production increasing in China -- I would say in the greater industrial and other spaces it's moving as we expected. It is a little bit more sideways, orders are improving, but when you look at it overall orders increased almost 10% from our fourth quarter to our first quarter, which is a significant step that we didn't see, as Tom talked about, as orders were stepping down quarter over quarter last year.

That's very helpful. Thank you.

From the line of Jim Suva with Citi, your line is open.

Thank you. And congratulations to you and your team there. A quick clarification question and my follow-up back to back. On the clarification, you mentioned a second-half improvement in industrial. I understand the inventory and distribution issues but what if oil stays at $30? I'm not smart enough to know if it's going to go higher or lower but if it stays at $30 is that supportive of your second-half recovery view? Does that pose a risk or does that impact it at all?

Then my follow-up is, on the timing of the stock buyback given the BNS sale, can you help us understand the cadence we should expect about that? In one hand you've been very diligent at always buying back stock each quarter. On the other hand, one would say why not do a big accelerated program so you get a bigger EPS benefit sooner, especially given the recent stock price volatility. Thank you very much.

Let me take the industrial question on oil and gas and Bob will take the share repo question. On oil and gas, one of the things that we have seen, certainly the program element of the oil and gas market we've seen in our stepdown of revenue. So, like I said, last year early in the year, as well as the year before, we would run about [$60 million] a quarter.

Our business as it's come down and oil has been impacted, we're seeing a lot of large projects obviously not happening, and there's not being a lot of large projects being bid. The $30 million per quarter level that we have right now is a maintenance type revenue level for us. It's not big projects. Whether it's $25 million, $35 million, $40 million, I do actually think that's a floor that we're going to be pretty close to plus or minus a little bit. I do think that element that we have in our forecast reflects current oil prices.

Jim, on the share repurchase, our intention remains we expect to be completed with the return of the proceeds from the BNS transaction in third quarter. As you know, we looked at a variety of different mechanisms to return that cash as we transitioned between announcement and actual closure, and came to the conclusion that the best answer was an open market transaction. There's a lot of reasons why an accelerated share buyback doesn't work for us. The easiest one to understand is we're a Swiss company and rules are different for Swiss companies, even though we're registered on the New York Stock Exchange, and that's make an accelerated very difficult to do.

Great. Thank you for all the details and congratulations to you and your team.

From the line of Mark Delaney with Goldman Sachs, your line is open.

Yes, good morning. Thanks very much for taking the questions. The first question is on the automotive business. I understand the long-term content opportunity, but in 2016 given that you're seeing China stimulus targeted towards low-end cars, are you seeing any short-term mix effects that are headwinds for content in the near term that you've thought about?

Mark, hi, it's Terrence. Clearly size of engine does impact it and it's just not that meaningful. I think when you take the penetration that we've done in China, both with the local OEMs and the multinational OEMs, the mix effect isn't what it used to be. And it is reflected in our guidance, certainly.

It's focused at 1.6-liter engines and below the stimulus. What's good is we cover every OEM there. We have content on it. It is in our guidance but it's pretty minor.

Okay, that's helpful. The follow-up question for Bob on the potential tax settlement, if that does get finalized with the IRS, how should we think about both other income and the tax rate going forward?

As you might guess, Mark, that gets really convoluted really quick. I think the most straightforward answer to give you is the settlement is not yet final. It's proposed. The two sides are largely agreed. We're working through a lot of nuances within the IRS to get that finalized and at this point anything I'd give you would be speculation and hypothesis.

We are very comfortable and, as was stated in the 8-K, we are very comfortable that we are adequately reserved and so there won't be an additional charge. And then going forward, once the settlement is actually finalized, we'll give some detailed guidance on the implication of other income and the go forward effective tax rate.

Thank you very much.

Thank you, Mark. It looks like we have no further questions so we thank you for joining us today. If you do have further questions please contact Investor Relations at TE. We hope you all have a great day.

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