泰科電子 (TEL) 2016 Q2 法說會逐字稿

Welcome to the Q2 earnings call.

(Operator Instructions)

As a reminder, this conference is being recorded.

I'd now like to turn the call over to our host, Mr. Sujal Shah. Please, go ahead, sir.

Good morning. Thank you for joining our conference call to discuss TE Connectivity's second-quarter results. With me today are Chairman and Chief Executive Officer Tom Lynch; President Terrence Curtin; and acting Chief Financial Officer Mario Calastri.

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, 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 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. Please turn to slide 3, and we will review the highlights from today's call.

Q2 was another quarter of good execution in what continues to remain a sluggish global economic environment. Adjusted earnings per share of $0.90 was $0.02 better than the mid-point of our guidance on sales of $2.95 billion, which were slightly below the mid-point of the guidance. Strong operating performance across the Company more than offset continued market softness across our industrial businesses.

Our adjusted earnings per share was down $0.01 versus the prior year, with foreign exchange headwinds of approximately $0.02. On a constant-currency basis, adjusted EPS was up 1% year over year. Adjusted operating margins were 14.9%, in line with our expectations, with adjusted EBITDA margins of approximately 20% in the quarter.

For the full year, we are reiterating the mid-point of our guidance of $12.3 billion in revenue and $4 in adjusted earnings per share, representing an increase of 11% over prior-year EPS. We expect to return to revenue growth in the second half and to generate double-digit EPS growth. Our outlook for organic growth is 3%, down slightly compared to our guidance of 90 days ago.

Our auto business remained solid. The industrial inventory correction is largely behind us. SubCom continues to build momentum. Our recent acquisition of Creganna is now in our guidance as well. These positive factors are offsetting the lower-than-expected growth in most industrial markets, and slow growth in our non-transportation business in China.

Our EPS growth is benefiting from cost controls, the benefits of our share buyback, and a bit of a lower tax rate. We have developed multiple levers to drive earnings growth in a slow economy.

During the quarter, we returned $1.2 billion to shareholders, including $1.1 billion in share buybacks. We expect to continue to take a balanced approach with our capital strategy, returning approximately two-third of our free cash flow to shareholders over time, with one-third of free cash being used for acquisitions. We generated $165 million of free cash flow in the quarter and $400 million in the first half of the year. We expect our normal strong second-half cash generation to continue.

We also continued to strengthen the Company's harsh environment portfolio. In March, we completed the sale of our circuit protection business.

Earlier this month, we completed the acquisition of Creganna, doubling the size of our medical business to about $500 million in revenue, and establishing TE as the leading provider of solutions to the high-growth minimally invasive medical market. This morning, we also announced a small sensor acquisition, which will strengthen our portfolio of sensor technologies serving the transportation markets.

In our SubCom business, we continued to gain momentum with the recently announced award of a project called Hawaiki, which is a new Trans-Pacific cable system linking Australia and New Zealand to the mainland United States. This award will generate over $200 million in revenue over the life of the project. This business has a backlog of awarded projects of $1 billion.

I'll now turn it over to Terrence Curtin, who will cover our performance in more detail.

Thanks, Tom. Good morning, everyone.

Before we get to the segment updates, I want to provide brief insights into our order patterns, which will help provide a baseline for our results, as well as the expectations. If you turn to slide 4, please, and this shows order trends excluding our SubCom business. Overall orders improved again sequentially and are above the low levels of approximately $2.6 billion that we experienced in the fourth quarter of 2015.

If you remember in the fourth quarter of last year is when we began to experience the supply chain impacts related to the slowing in China, as well as the industrial markets. We have seen recovery in orders in both of these areas, and feel that the supply chain correction effects have completed in our second quarter, as we expected.

Certainly, we are pleased with the recovery in the orders; however, the slope of the recovery is running behind original expectations in certain areas. Specifically, in China, we previously thought that orders would continue to accelerate through the rest of the year. While we believe the auto orders in China will continue to recover, we are now expecting orders outside of auto to sort of remain at the current levels that we experienced in the second quarter.

Let me now talk about the orders by segment. Overall transportation orders remained solid, and in auto, our orders were negatively impacted by a near-term customer backlog adjustment that related to a change in their scheduling.

I want to highlight, this does not impact demand. It's really just a change in one of our customer's processes. We continue to experience strong order trends both in Europe and in Asia in automotive.

In industrial, orders grew 5% sequentially, with growth in both our direct customer orders, as well as those that go through our channel partners and distribution. As I stated earlier, the industrial inventory correction is now behind us. In communications, excluding SubCom, our orders grew 4% sequentially, with a book-to-bill of 1.05, with improvement in both our appliances and data device businesses.

As Tom mentioned, in SubCom, it continues its momentum with the new Hawaiki program. We will record that order as a booking in our third quarter.

If you could please turn to slide 5, I'll discuss transportation solutions results in the second quarter. Overall sales grew 3% in the segment organically in the quarter, with growth across all our businesses. Our auto sales growth in the quarter was driven by strength in China, as well as in Europe.

For FY16, we continue to expect global auto production to be up 2% to 2.5%, with growth in all regions, and strong growth in China. We remain confident that our auto business can grow ahead of auto production, driven by electronic content growth as well as a rich pipeline of platform [range] from design wins that were generated over the past several years.

In commercial transportation, sales grew 1% organically year over year driven by the heavy truck sector in both China and Europe. North America heavy truck markets continue to remain weak, along with continued weakness in global construction and ag markets. We're pleased that organic orders were up both year over year as well as sequentially, as we continue to perform very well in this business in a tough economic backdrop.

Turning to sensors, we saw 2% organic growth, as we did begin to feel the impact of weakness in the industrial markets in our sensor business. Just a highlight for you, about 40% of our sensor sales go into the industrial markets. We do continue to see strong design momentum in long-cycle transportation and industrial applications that we expect will drive future growth.

From a margin viewpoint, adjusted operating margins in the segment were 19% and were in line with our expectations, and were up sequentially. The decline year over year was driven by currency impacts, as well as investments for growth. We anticipate adjusted operating margins for the second half to continue to improve, and should be at similar levels as the second half of last year.

If you could please turn to slide 6, I will discuss the industrial solutions segment. Revenue in the segment declined 7% organically year over year in the second quarter.

Geographically, we continue to see trends across our businesses that are consistent. Europe is stable and growing in many markets. North America continued to see weakness due to oil and gas, as well as the supply chain corrections that impacted us the past couple of quarters. China remains sluggish.

We continue to be impacted by the oil and gas market, which saw a 42% organic reduction in sales year over year. The decline in oil and gas drives half of the organic decline in the segment in the second quarter. Low oil and gas prices continue to have a derivative effect in other areas of the industrial segment, including factory equipment, as well as in helicopter demand, which affects our aerospace business. We have included the impacts in our results as well as in our guidance.

In aerospace and defense, our commercial aerospace business grew year over year. This was more than offset by declines in the defense business due to supply chain effects that were occurring in the distribution channel. Our energy business was down 2% organically, with declines in Asia and in Europe, partially offset by growth in the US.

As we look forward, we expect the industrial segment to grow sequentially. We expect it to be essentially flat organically year over year in the third quarter. We expect it to return to growth in the fourth quarter, now that the inventory corrections are behind us.

Adjusted operating margins were down year over year, driven primarily by declines in the higher margin oil and gas business. But they were up sequentially. We do expect adjusted operating margins to continue to improve in the second half, benefiting from the increased volumes, as well as the cost action that we've initiated.

If you could please turn to page 7 to talk about the communications segment. In the second quarter, the segment had revenue of $606 million, which was down 10%, and 8% organically, year over year. It was slightly ahead of our expectations.

Our SubCom business saw solid year-over-year growth, driven by strong execution from multiple projects in force. As Tom mentioned earlier, the total value of programs in force is approximately $1 billion. We now expect SubCom to grow approximately 20% year over year. This is an improvement versus our expectation 90 days ago.

Our data and devices, and appliance businesses were impacted by distribution inventory corrections, as I mentioned earlier. We believe these are behind us as we head into the second half of the year. Additionally, data and devices growth is impacted by the product exits we've been highlighting all year as part of the repositioning effort, and as discussed, will impact our growth rate throughout this year.

Adjusted operating margins in the segment declined 60 basis points year over year, in line with our expectations. We do expect improvements to adjusted operating margins as we continue through the second half.

Now, let me turn it over to Mario, who will cover the financials.

Thanks, Terrence. Good morning, everyone.

Please turn to slide 8, where I will provide more details on earnings. Adjusted operating income of $440 million was in line with guidance and down 13% year over year due to currency impacts, investments in transportation, and the lower volume impacts that Terrence mentioned earlier. GAAP operating income was $535 million and included $4 million of acquisition-related charges, and net restructuring and other credits of $99 million, primarily driven by a gain on the sale of our circuit protection business.

Adjusted EPS was $0.90 for the quarter, down $0.01 from the prior year with reduced volume from higher margin products and negative impacts from currency exchange rates offsetting incremental benefits from share buybacks. Excluding the $0.02 impact from foreign currency, adjusted EPS was up $0.01 from the prior year.

GAAP EPS was $1.06 for the quarter, driven by net restructuring and other credits of $0.17, primarily due to the circuit protection sale I just mentioned. We expect approximately $100 million of restructuring charges for the full year, a $50 million increase from prior guidance.

Regarding tax, you should continue to think of TE's long-term adjusted tax rate at approximately 23% to 24%. Due to the mix of profitability in different jurisdictions, we now expect our adjusted tax rate to be slightly lower this year.

As we mentioned last quarter, Tyco International on behalf of TE entered into an agreement with the IRS to resolve all disputes related to the previously disclosed inter-company debt issues. During the quarter, we made net pre-separation tax payments to the IRS of approximately $140 million to prevent further accrual of interest and penalties, and hope to have this settled and behind us in the near future.

As you may know, the Treasury Department issued proposed tax regulations earlier this month. One proposal addresses the tax characterization of certain inter-company financing arrangements. Like most multi-national companies, TE utilizes inter-company financing for efficient capital deployment. We are in the process of analyzing these proposed regulations for any potential prospective impact on TE.

Turning to slide 9, while we remain in a challenging environment, our performance was in line with our guidance. We expect improvement across our operating metrics in the second half.

Our adjusted gross margin in the quarter was 32.6%; the decline from last year is mostly driven by lower volume in areas like oil and gas, and distribution, which have higher margin than Company average. Adjusted operating margins declined 150 basis points, consistent with our gross margin performance.

Total operating expenses were $523 million in the quarter, down 5% from the previous year, reflecting strong spending controls. Continue to tightly manage discretionary spending while balancing our continuing investment into our harsh businesses.

Moving to cash flow and capital deployment, in the quarter, cash from continuing operations was for $155 million. Our free cash flow was $165 million, down from prior-year levels due to timing of certain tax payments, but still up in the first half versus last year. We expect full-year free cash flow to approximate net income.

We continue to have a balanced capital allocation. In the second quarter, we returned $1.2 billion to our shareholders, including $1.1 billion in buybacks. In the quarter, we bought back 19 million shares, executing against our commitment of returning the proceeds from the broadband networks divestiture.

Over the past 18 months, we have returned approximately $4.3 billion to our shareholders through buybacks and dividends. As Tom mentioned earlier, we expect to continue to take a balanced approach with our capital strategy going forward.

We're also including a chart on adjusted EBITDA margins, which helps explain the profitability performance of our businesses, including acquisitions. Adjusted EBITDA margins in Q2 were 20%, and show 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 platform. We've also added a balance sheet and cash flow summary in the appendix for additional details.

Now, let me turn it back to Tom.

Thanks, Mario.

Before I get into Q3 guidance on slide 10, let me provide some perspective on why we will return to growth in the second half. As you know, our first half was characterized by several year-over-year macro headwinds: unfavorable foreign exchange due to the significant strengthening of the dollar against most major currencies; the significant decline in year-over-year oil prices, which resulted in an over 40% decline in our higher margin oil and gas business; overall industrial markets weakened, leading to a supply chain correction with OEMs and our channel partners, which we believe are now behind us; and weakness across most China markets.

In the first half, these factors impacted us significantly. In the second half, most of these headwinds are reduced. As a result, we expect to return to revenue growth and strong double-digit adjusted EPS growth, driven by our harsh strategy and the many levers in our operating model.

Now I'll cover the Q3 outlook. We expect Q3 revenue of $3 billion to $3.2 billion, up 1% on an actual basis and flat organically, and adjusted earnings per share of $1 to $1.06, up 14% year over year at the mid-point.

We expect growth in transportation and industrial, which includes approximately $60 million from the Creganna acquisition. This is offset by declines in communications from the sale of the circuit protection business, and the continuation of our strategy to exit certain product line in data and devices. We do expect continued growth in our SubCom business.

Now please turn to slide 11. We are reiterating our full-year guidance of $12.3 billion in revenue and $4 in adjusted EPS at the mid-point. On a full-year basis, continued strong performance of our transportation segment, the addition of the Creganna acquisition, and growth in our SubCom business is more than offsetting the negative impact of exchange rate and softer industrial markets, especially oil and gas, and China. As mentioned earlier, the full year and fourth quarter includes a 53rd week, which contributes approximately $200 million of revenue.

Now, this full-year outlook includes an unusually high Q4 revenue and EPS level compared to Q3, so I'll walk you through that. As previously mentioned, this year's fourth quarter includes an extra week, which contributes approximately $200 million of revenue and approximately $0.10 per share in earnings. Excluding the 53rd week, revenue is increasing approximately $40 million from Q3 to Q4.

So, the way to think about this is the $240 million revenue will flow through to earnings at a 25% to 30% rate. This, coupled with our typical productivity, accounts for the significant sequential increase in EPS.

Let me just wrap up with a few comments. As we mentioned earlier, the global economic environment continues to be sluggish. Despite this, we expect to generate another year of solid performance.

Our focus on harsh environments, driving TEOA through the Organization, strong cash flow, and a consistent return of capital policy continues to enable us to significantly strengthen our earnings leverage. $1 of revenue today generates about 40% more EPS than five years ago. This is serving us very well in a slow growth economy, and will deliver accelerated earnings growth as the global economy improves.

Now, let's open it up for questions.

Thank you, Tom. Mariah, can you give the instructions for the Q&A session, please?

(Operator Instructions)

Amit Daryanani, RBC Capital Markets.

Two questions for me. Tom, maybe you can carry on with what you ended the call with, the September-quarter guide. Historically, I think in September revenues seemed to be down a little bit sequentially 2% by my math. So could you maybe talk about what gives you comfort that sales could be up $40 million sequentially on an organic basis? Then on the EPS line, I guess the same thing, the extra week gives you $0.10, the $40 million would give you another $0.02, $0.03? I still struggle to get the entire $0.20 that you are implying for September.

Hi, Amit. I think there's a little static on the line, but I'll try to get through this. Yes, normally, if you go back over many years, we had a few years where we're up slightly in the fourth quarter, a few years where we're down slightly. Last year was a pretty unusual year because that is where China and the industrial (inaudible) began to occur. This year the pattern coming into the fourth quarter is different. You have industrial markets improving. You have China while not quite as much as we thought improving -- for sure the auto market is improving as we expected. So that's really the difference accounting for us, a slight sequential improvement as opposed to what you could say, over time has been kind of a flat to (inaudible).

We also pickup -- when you add $240 million in revenue sequentially a lot of leverage comes with that. That's how you, I think, will for sure (inaudible) to 30%. The restructuring that's been going on through the year continues to flow in and aggregate so they'll be a better benefit in Q4 than Q3. Then our normal productivity momentum which marches through the year, so when you add all that up, that's how you get to what looks like a pretty significant hockey stick, when you peel back and say it's a small hockey stick.

Fair enough. That is helpful to get the leverage there. I guess just the transportation segment, I think you actually took up the production -- or unit expectation up modestly for autos. But the organic growth I think went from high single digits to mid single digits. Can you just talk about what are the variables that's leading to the lower organic growth within transportation for the year?

Hi, Amit, it is Terrence, two things, we did not change for [our known] production estimate, we've been around that 2% to 2.5% since last quarter and really that is China being middle to higher single digits, Europe being about 1%, US about 4%. So that's -- we have not changed those assumptions.

When you look overall at the transportation organic growth primarily driven by the comments I made around sensors, we did reduce our expectation for the year around sensors organic growth to really relate it to the impact of the industrial markets. So the growth we had there was lower this quarter than we thought. We are seeing order impacts due to some of the industrial impact that we've seen elsewhere on the sensor business.

Perfect. Thank you.

Wamsi Mohan, Bank of America.

Terrence, you pointed out strength in autos in Europe and China. I was wondering if you could talk about the order patterns in North America in auto. Are you seeing any signs of deceleration in order patterns that is concerning to you at this point? I have a follow-up.

Wamsi, thanks for the question. The one off comment I made around the backlog adjustment that was in our US business. But that was really a scheduling change by a customer. That it not have anything to with demand. What we have seen in North America, we have seen some leveling of order patterns is how I would describe them. I would say there's an acceleration or a deceleration outside that specific adjustment with that customer, but otherwise I would say a leveling.

Okay. Great, thanks. As my follow-up, transportation margins saw a year-over-year decline despite organic growth of 3% and reported of flat. Can you address what the moving pieces are? I think you called out FX and some increased investments. What are those increase investments specifically? If you can give any color on that. Thank you.

When you look at those increased investments, we've had a tremendous amount of program wins both in our sensor business as well as in the automotive business. As you know, they're long-cycle businesses, Wamsi, so we have been putting investment in to support those programs. So it's mainly an engineering and product launch teams both in sensors as well as core automotive around those program launches that will benefit us in future years.

Sherri Scribner, Deutsche Bank.

I wanted to get a sense of what drives your confidence that the industrial segment will improve in the back half of the year. It sounds like you think China's going to be relatively flat, but potentially I think you're saying that the inventory situation is better. So just trying to understand what makes you comfortable that things will get better in the second half? Thanks.

Sure. Thank you. I'll comment and then I'll have Terrence add to it. I think a couple things, one, when we look at inventory in the supply chain both at our direct customers and at our channel customers, it feels like that's back in balance right now. That's what our channel partners feel as well. So that's -- when the business started to go a little bit -- flatten out last year, the supply chain adjusted negatively, so we been going through that.

We do see China gradually picking up. It really began to turn down in the second half of last year and in the fourth quarter of last year. So some of that is a compare. I don't think we're predicting -- we're not predicting a robust industrial market. It's really things getting more in balance. Then we'll have the benefit of the Creganna acquisition, which is in our industrial segment. So, Terrence, do you want to add some more color to that?

No, I think, Sherri, Tom said it very well. Last year in the fourth quarter is when oil and gas as well as a lot of the channel and inventory FX hit us. So in some ways it's a weak compare to the fourth quarter last year on an organic basis. But we do see them leveled out. I think the third quarter as we talk about it being flat year on year I do think the industrial world is relatively flat right now. So I think we are getting those supply chain FX behind us, anniversarying oil and gas as well as Comair we continue to expect to be a very strong market and as Tom mentioned, medical (inaudible).

Great. That's really helpful. Then can I just ask a quick question on the communications margins. They were down year over year and I would thought they maybe would have been a bit stronger given the Subsea business is higher. How should we think about the Subsea business impacting that margin as we move through the year as revenue is stronger? Thanks.

Subsea -- communications as you know is a mix of three businesses, a very good appliance business that -- Subsea business that is growing. The first-quarter margins were very high because we had the close out of a job in Subsea that we expected to take a couple more quarters. That really popped the margin in the first quarter. The second quarter is more normalized for Subsea. So I'd expect Subsea will gradually improve. The data and devices margins will start to improve later this year.

But we are feeling more optimistic about that. We did -- we're taking the circuit protection out, that was in, in the second quarter but that is not in, in the balance of the year. So when you go business by business: appliance, strong margins, steady. SubCom, take the first quarter out, it's a little bit of an aberration growing as volume grows and data and devices, poised to start improving next year based on what we see right now.

Craig Hettenbach, Morgan Stanley.

Question on Creganna, understanding it just closed. But if you could just give some antidotes in terms of customer engagement, number one. Number two, what that does for you more broadly in the medical opportunities set?

Sure, Craig, it's Terrence. So let's -- the reaction from the customers have been very positive. Certainly, we made the first move in this space last year with AdvancedCath. I think the customer reaction of having both of these together and to get bigger scale in a space, where like we said, it's about a $3 billion market of which we are basically the number-two player right now in that. Customers have really appreciate it. So that's a real positive.

I think secondly as we talked about -- to the second part of your question, around what does it do? What's really nice about what Creganna does for us is really rounds out the portfolio. So, just to remind everyone, it gets us to about 90% of that integrated solution of we'll have internally. I think the other thing that is very powerful, not only their position and their engineering but where it's positioned in the world really balances out our medical platform. They fill it not only with manufacturing both [could be] engineering and fill the gap we had around Europe with their strong Irish presence. Then clearly bringing in 225 engineers that know that space, knows [the applications] really doubled our engineering capability.

So really we feel have a very nice platform to continue to build upon. Very early but very excited about it as well.

One thing I would add, Terrence, is we complement Creganna in China, with our size in China and our robust platform across China and an existing medical business there in that market is made to order for minimally invasive because you have the growing -- the huge population, an aging population and you don't quite have the affordability. So this -- we're really excited about helping them scale much faster than they would've normally been able to in China.

Got it. Thanks. Then as my follow-up on the tuck-in announced this morning, if I look back to MEAS they were -- the number of tuck-ins and in many deals you kind of build the base that you have today. So just your strategy in the sensor from market, it feels like that's a market that's very fragmented. There is a lot of growth. There's a lot of opportunities, but could we expect more along these lines in terms of you doing these type of $40 million or $50 million type revenue deals.

Craig, I think you said it very well. Number one is, it's very fragmented market. What we liked about what was announced today [which you kay], which really is this is a speed sensor that product company that really plays very strongly into transportation both in the industrial transportation side as well as automotive and to turbo charger applications. So I think when you look at the sensor space, you'll continue to see us do things similar to this then as we continue to build out the portfolio and build (inaudible) as what we had historically and continue to grow this business. So, very excited about the business we announced last night. I think it will help strengthen us in the transportation space.

Got it. Thanks for that.

Shawn Harrison, Longbow Research.

Just the buyback, just to be clear on the math, is there about $1.1 billion now available on the buyback? Should we assume the June quarter gets you back to the normal cadence of say $150 million to $250 million type of activity?

Hi Shawn, this is Mario. We still have actually about $1.3 billion of authorized. Just a reminder in terms of what we talked about in the comments, our strategy remains very much consistent with the past and a reminder of what we have accomplished in the last 18 months. Then Tom is going to add anything.

Sure. I would say, yes, we're going to get back probably to the lower end of the normal range in the next couple quarters. We bought back $3 billion over the last nine months. We did make the Creganna acquisition. But we feel this two-thirds, one-third split really works for us. We haven't seen anything that changes our view from a strategic point of view, that's the sensible capital allocation. As you know, all of you who have been following us for a while, there was periods where it's a lot higher than two-thirds return of capital. Then there's periods when we make any kind of sizable acquisition where it dipped below that.

Okay. That is helpful. As a follow-up just on auto in general, maybe -- it's a two-parter. Have you seen any impact from the earthquake in Japan? I think Toyota was give or take around $0.5 billion customer, if my notes from 2011 are correct. Then just also on what you think the impact of China stimulus is on the business this year? How that could affect the business rolling into FY17?

Hey Shawn, it's Terrence. Thanks for the question. First off, let's take Japan. What I would say of Japan, I think your sizing of Toyota's about right. When you sit there and you think through the earthquake in Japan, clearly that's a fluid situation that we're monitoring with our customers. We have not seen any disruptions yet. We're sort of assuming normal pattern, but where we see demand at it may impact some timing a little bit. But we're talking to our customers constantly and making sure we are helping them any way they can as they work through that tragic event in Japan.

On China stimulus, I think that's a little bit more of a complicated question that when you look at it, we did get impact in our first quarter as China's overall production adjusted, so we talked about that. What we have seen is China coming back to about a 6% production environment here post that, which is pretty much in line with GDP. I don't think we know whether the China stimulus accelerated some production or demand, but we do sort of view that China production long term will stay around GDP of China. So, I don't think we're far off right now. I think we'll have to see as the stimulus works off if there's any timing effects, but right now, we feel pretty good as production has re-stimulated post the first quarter being very slow for us.

Mark Delaney, Goldman Sachs.

The first one is a follow-up on the Q4 guidance. I know you've talked about some of the top down factors that you're thinking about in terms of the different end markets. Can you help us understand, is there anything that you're getting from specific customer forecasts that are giving you a lot of visibility that Q4 is up sequentially from Q3? Anything on the lead times? I thought they were normally four to six weeks, so it seems like it's more top-down driven. But if you have a bottom-up reconciliation that's giving you more confidence, it would be helpful I think.

We have a lot a customers, so there's a lot of data points. I would say, the biggest indicators are just -- on one hand, what we said in industrial. So we do see that sequential growth in orders and it continued into April pretty solidly. So that gives us confidence, it doesn't -- it's not a slam dunk. The channel partners all pretty much back to positive book-to-bill. Seeing POS in line with increasing demand and reflecting inventory levels in the channel back in line.

So those are all positive indicators. If you'll recall at this time last year, those indicators were starting to -- no, they were raising caution flags. They were going the other way. So, that's what's given us some optimism. Again, we are not expecting a boom from Q3 to Q4. I think it's just where the cycle is this time versus prior years. Of course, got to always keep reminding you of that extra week. It's confusing to all of us.

But there's an extra week there. So when you strip that out, we're talking about $40 million in revenue pickup. But right now, it feels -- we think that's balanced. We'll know a lot more at the end of the third quarter, but when we look at what the channel pattern is versus prior years, when we look at our industrial businesses' quarters sequentially and seeing it both in the OEM customers and the channel customers that's what gives us that confidence. Terrence, do you want to -- did I miss anything there?

No. I think you said it very well, Tom.

Okay. I appreciate the additional color there. Then a follow-up question on the tax rate commentary and actually a two-parter. I think 23% to 24% was the comment. What sort of FX should we expect for the potential settlement around the old Tyco liabilities. Should we be looking for any other income line? Are there changes there? Can you just clarify, does the long-term guidance of 23% to 24% include what you think a potential impact might be around earnings' stripping regulation? Or you just haven't had chance to better put that into numbers yet?

Yes to part of the question, I think that what we talked about in the comments, our expectation for the longer term remains at 23% to 24%. That does not include any indication around regulations because it's really too early to talk about any potential impact there. (multiple speakers) When it comes to the second half, we do expect it to be a little bit lower than that 23% to 24%. That's mostly driven around distribution of profitability around jurisdiction more than expectation around [some].

William Stein, SunTrust.

I'm still having trouble understanding your comments about the transportation segment. I think that you noted that automotive is at least as strong as it looked previously and that the downward adjustment to the full-year guide in that segment is related to the sensor business. So you are seeing -- it sounds like you're seeing industrial sensor applications roll off just at the same time that you expect the rest of the industrial exposure to start to improve. So maybe you'll start by reconciling that. Then I have a follow-up, please.

Let me start with that, I think, Will, on -- the way to think about the sensor piece of that is growth is slowing whereas in the connector part of the business growth was down, right? Because of inventory correction. So now we expect what's going to happen in the second half of the year in the industrial connectivity business flat and then a little bit of growth in Q4. But sensors is a different story, it's just really growth slowing reflecting this uncertainty out there. Terrence, you want talk more about transportation?

Yes. No, Tom, you said it well. When you think through the interconnect piece of industrial, about 50% of it goes through distribution, in sensors very little does. So what we have seen is we've actually seen our sensors industrial actually come down and slow more like our direct customers. So, Tom is very much right on it. In the rest of it, transportation, Will, it is like we said in the comments, we see a production environment staying steady at that 2%, 2.5% growth. Certainly trying to be the big driver of it, Europe being up slightly. So we see that continue to be solid. Transportation, when you say it's down a little bit, it really has to do with that sensor comment. Perhaps (inaudible).

So the follow-up there is that within transportation, sensors are still quite small. I don't know 10% or 15% of the sold transport. I suspect that what's really driving the full-year difference is some -- you made a comment on the prepared remarks around a supply chain or some other inventory adjustment that one of your customers is making in North America. Can you help us -- what we are really trying to understand is this -- what's going on here? Is this sort of a valid read as to what's going on in the industry? Or is this particular to TE? Is it very temporary and then it snaps back? Or is their bigger problem here? Thank you.

Will, it is actually just how customers schedules orders into it, they change their process. So it does affect the numbers, it does not affect demand. That did impact our orders, but it did not impact the demand we are seeing from customers. So really it's just their process of how they gave orders. They've changed from more real-time than giving us a firm full-out calendar view of it. That adjustment impacted our orders, but it doesn't impact the demand patterns at all. It's just how we do business between the two companies.

What I would add, Will, is just to help the understanding of it here, is our automotive business will grow more in the second half than it does in the first half. So, we're not -- the mixes are changing, North America plateauing a bit, China picking up, Europe steady. But when you step back to your question, hey, is there something going on here? We actually are going to have a stronger auto business in the second half than the first half. The overall sensor business growth rate is lower in the second half than the first half.

I would -- just one last comment, Will. In that 2.5% production environment, we do expect to be mid to high single digits in our automotive business.

Thank you.

Steven Fox, Cross Research.

Two questions for me, first off, just getting back to the transportation margins. I understand the investments that are going on, I'm just curious if you could just give us some bigger picture comments on how your managing those against our own short-term expectations for margins in that segment versus what's an expanding opportunity for growth? Then I had a follow-up.

Sure. (inaudible) this aggregate for a moment, the three pieces of our transportation segment. Automotive, as Terrence said, very strong business. Expect to grow mid to high single digits on 2% to 3% -- 2.5% production growth, margins there remain strong. Sensors is below the transportation averages as you know with the acquisition with tremendous opportunity to move those margins up. We are investing at a -- we're increasing our R&D investment at a faster rate than our sales growth in sensors because the opportunity is so great. Customers absolutely like another strong, resilient, technology-rich Company providing sensors into the transportation market.

We are getting significant design ins and that requires engineers, it's been our plan from day one when we made the acquisition. Then in the industrial transportation business, which is the highest margin business in the group, we are -- no, I think we're navigating very well, maintaining our margins in a very almost really negative growth environment, our growth is up because of our strong position in China and in Europe, which is offsetting North America. So we really, within the segment, we manage those businesses separately based on the dynamics and the opportunity.

As Terrence said in his comments, we're pretty confident that you'll see the margins improve again sequentially. They went up 40 or 50 basis points Q1 to Q2. We expect that march to continue in the second half of the year with a little bit of volume growth over the first half of the year, because there's a lot of operating leverage in the business.

So just to push back on the second point around sensors. So is it safe to understand then that this was sort of an unusual quarter in terms of the investment levels versus revenues actually ramping with some new programs and that gap starts to close going forward? Or does it stay at these levels for a little while? If you could sort of qualify that? Then my follow-up question was just to get an update on the CFO search. Thanks very much.

Sure, Steve. It is ramping. We began increasing our sensors investment late last year and certainly as we win programs -- and we talked about our design wins, especially in longer cycle businesses, there will be a gap. So, I don't think it's an anomaly, but it's something we have to invest ahead in as we win these programs. So it is a ramp that you are going to see in sensors. But we always expected that as we build the business.

One more comment before I address the CFO search, I think it's really important if you look at the transformation of the Company to harsh environment out of businesses that don't fit that definition. You know for us that is highly engineered, high barriers to entry, the capital allocation strategy, you see how that enables us even in a slow growth market to make strategic investments in something like sensors, which is going to be a big business for us. So yes, we have decided not to really change our strategy there given that we have all these other levers to drive the earnings growth that we set up six months ago, [$12.3, $12.4] billion in revenue and $4 EPS. So, that's part of the story too, an important part.

On the CFO search, we're active as you can imagine. We have several internal candidates. We are going through the external candidates, obviously a critically important job. But I feel good about is we have a very strong financial organization across the Company. The team is doing great, Mario has stepped in, as you can tell. In an effective way, he's been with us 10 years and knows us very well from all dimensions. But, yes, that's a every day item on our list. I would expect in the next couple months we'll be making some announcements.

Great. Appreciate the color.

Jim Suva, Citi.

When you mentioned on the prepared remarks as well as a little bit on the Q&A about your automotive customer changing its supply chain a little bit, can you give us some details, like did you benefit from that in a prior quarter? Or it sounded like this quarter you had some weakness associated with that. Do you then in the future recoup that weakness because it seems like at the end of the day, the supply chain has to all connect itself.

Was that change, I assume, led by the customer and it is then going to be rolled out globally to them? Or already has it? Is it centered around petroleum or diesel or electric or HV? How should we think about kind of what's going on there? Is this a rippling change to the industry?

Then my second question or the follow-up would be, on the inter-company debt, I know you mentioned that the past historical IRS settlement is in the works and you're accruing the interest for it and so on and so forth. Am I also correct to say that the new regulations also potentially and/or do impact your current debt structure amongst the Company? If so, can you quantify or let us know about anything around that? Or was it all just simply backwards dating and going forward there are no considerations? Thank you.

So, on the first -- I'll take the first point then I'll let Mario take the second point. Number one, it's at a customer, so when you look at programs and things like that, Jim, you can't really look at them. They change their process. So, certainly, this was something that built up over time. It is the way they did the process. They gave us very forward-looking orders that we recorded as orders and backlogs. Now they've moved to be a more current JIT.

With the way I would articulate it, that as scheduling came out and they're going to hit us with orders more frequently. That does create a de-booking in our world. It does not impact the programs that we've won with that customer throughout the world. So when you look at, it is something that is very process centric. It does not impact programs. You can't get it into individual -- it's diesel versus electric versus combustion engine, it isn't there. Over time, we'll just get those orders in more frequently than having a scheduled backlog. Now, I'll let Mario turn over to the second piece on your tax question.

Sure. On the tax question, first of all on the settlement, we did mention that we have made a prepayment to the IRS that effectively stops the accrual of interest on that liability, which basically takes out most of the impact of the settlement when we're likely to settle. So we already have included in our guidance the fact that we have made that payment that impacts our tax rate. On the second element as far as the regs that are put in place. First of all, those regs -- those proposed regs are perspective so they do not have any impact on our current Company debt position. Again, it's a complicated matter that we are getting our heads around, but no, there is no impact to our current inter-company debt position that would be only perspective.

Great. Thank you very much.

Mike Wood, Macquarie.

Realizing that your visibility is very good on the auto platforms, can you just give us your incremental enthusiasm or concerns over just where your share will be moving over the next several years? Has there been any platform wins on the passenger vehicle side from measurement specialties?

Yes, sure, thanks. Yes, I mean, geez, I couldn't -- I have to contain my optimism around the automotive business globally. With our presence and our range of technology it's becoming more and more important. So, we have a significant share in the connectivity business. But over the last five years, we believe we increased that 5 points. That is quite an accomplishment and it really is as these solutions get more complex and all you have to do is kind of look under the hood and see how different is over the last five or six years,

The connectivity and the sensing solutions are more complex. On the connectivity side, we continue to win at a rate faster than we have in the past, which is why I think we said a few times, if you go back five years and we talk about a 2% production environment, we would have talked about a 3% -- 3% to 4% revenue-to-TE environment, now we believe that's a 5% to 6%. That's really more market share than it is content. So I expect we'll continue to inch up our market share because of the range of capability we have. Just for example hybrid electric vehicles; the difference in our designing in-rate in the last three years versus the first -- the prior five years is 2 to 3 times.

So, as that market now continues to pick up, we have -- it's high content and we're extremely well positioned with all the leading platforms. So, feel good about that. On the sensor side, we have one significant designs ins with the [ascent de Mage] technology and our go-to-market and our -- the strength we bring and the credibility we bring to an auto customer. We are an auto supplier, through and through. We've been doing that for 50 years.

So they like the technology and they trust us. We are winning important awards, they're not showing up in revenue yet. That'll be in the next couple years, but that's why when we talked about earlier incredibly enthusiastic and feel that actually ahead of the hypothesis we had with Mage about our ability to bring their technology into the auto market which is the best market for sensors. Terrence, do you want to add anything to that?

No, I think Tom just said it well. Then also, even with the small acquisition, it continues to give us confidence that we're able to leverage our go-to-market in the transportation area, like Tom said. So, I think our program wins we've been getting, the other thing that's nice about them, they are in all geographies of the world. It's not just concentrated in one geography, which actually leverages that great go-to-market that we have in our auto business that we always talk to you all about.

Great. As a follow-up, on the industrial orders, can you just give us the breakout of the OEM trend versus the distributor order trends in the quarter?

Yes. Sure, Mike, just let me grab it quick. When you look at it, the trend in the quarter between the two that you had -- what we saw on the OEM side year over year was relatively flattish. Then on the channel side, we were still down year over year, but what's nice is it was getting back to where last year's quarter levels were, which gives us confidence that when we get to the third and fourth quarter, our channel sales versus last year will be up because we did have that correction in the fourth quarter.

The other thing that Tom mentioned that I think is important, our channel partners have seen positive POS. They are seeing a book-to-bill greater than 1, so it's not only our order patterns. As we've talk to our channel partners, they have also seen their book-to-bill go back above 1 as well as positive POS. So it's a combination of those factors that we see.

Great. Thank you.

Mark Delaney, Goldman Sachs.

Just a follow-up on the tax rate question. Once the Tyco liability is settled, should we be thinking about the other income from Tyco and Covidien going to zero? So tax rate 23%, 24% but assume that no other income from that going forward?

Mark, sorry, let me clarify. The way you should think about it is that the settlement is going to be basically EPS neutral. There's going to be [as little] between the other income that's going to go away and the tax rate is going to get lower. Now, at this point, the guidance and what we talked about, the 23% to 24%, and being a little bit lower in the second half, does not include the settlement. So we're just not including the settlement (inaudible) but you should think about it as EPS neutral because we have done the prepayment to the IRS. So we basically stopped the accrual on the (inaudible).

Thank you.

We have no further questions. So, thank you very much for your time this morning.

Thanks, everybody.

If you have more questions, please contact Investor Relations at TE. Have a great day.

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