泰科電子 (TEL) 2018 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by. And welcome to the TE Connectivity Q2 Earnings Call. (Operator Instructions) As a reminder, this conference is being recorded.

I'd now like to turn the conference over to our host, Vice President of Investor Relations, Mr. Sujal Shah. Please go ahead, sir.

Good morning. And thank you for joining our conference call to discuss TE Connectivity's second quarter 2018 results. With me today are Chief Executive Officer, Terrence Curtin; and Chief Financial Officer, Heath Mitts. During this call, we will be providing certain forward-looking information, and we ask you to review the forward-looking cautionary statements included in today's press release. In addition, we will use certain non-GAAP measures in our discussion this morning. We ask you to review the sections of our press release and the accompanying slide presentation that address the use of these items. The press release and related tables, along with the slide presentation, can be found on the Investor Relations portion of our website at te.com.

(Operator Instructions) Now let me turn the call over to Terrence for opening comments.

Thank you, Sujal, and thank you, everyone, for

joining us today to cover our second quarter results. Before I get into the earnings slide that we posted, I'd like to briefly recap our performance and our guidance against the elements of our business model that we shared at our investment -- Investor Day this past December. I feel our results in the quarter and our guidance demonstrate both our execution of our business model as well as the trends to drive above-market growth. On the topline, we delivered 7% organic growth in the second quarter and are raising the midpoint of our full year organic revenue guidance to 6%. And this is at the upper end of our 4% to 6% long-term organic growth target. Our revenue growth continues to be driven by the secular trends, enabling TE to consistently outgrow the markets that we serve. Also in the middle of the P&L, we're executing on the levers to drive operating margin expansion. Our SG&A expenses were down year-over-year as a percentage of sales, and we do expect that trend to continue for the full year. On the bottom line, we expanded adjusted earnings per share by 19%, and we're raising the midpoint of our full year's EPS guidance to reflect 15% growth. This is also in line with the annual double-digit earnings growth target in our business model. We also continue to maintain a balanced capital strategy through share buybacks, dividends and a disciplined approach on acquisitions. At the same time, we continue to focus on our top priority, which is to invest in the organic growth of our businesses, while maintaining ROIC levels in mid-teens. Now if you could please turn to the slides. I'll start with Slide 3, and I'm going to review the highlights from the second quarter.

We delivered performance above our guidance with double-digit growth in revenues and adjusted earnings per share. Sales were $3.7 billion, representing 16% reported growth and 7% organic growth year-over-year. In Transportation, we grew 10% organically, with growth in each of our 3 businesses and across all regions. Industrial Solutions grew 6% organically, driven primarily by industrial equipment, commercial aerospace and defense. Our Communications segment grew 1% organically, with 10% combined organic growth and Data and Devices and appliances, more than offsetting expected declines in our SubCom business. In the second quarter, we delivered 17% adjusted operating margins with strong margin expansion of 80 basis points in Transportation and 100 basis points in the Industrial segment. Our adjusted EPS grew a very strong 19% to $1.42 per share, another quarterly record for our company. Based upon the continued momentum across our businesses as well as the positive effects of currency exchange rates, we are raising our full year sales and adjusted earnings per share guidance. Organic growth expectations are being raised from 5% to 6% for the year, reflecting the second quarter strength and some additional organic growth in the second half versus our prior view. We are raising our outlook for reported sales from 8% to 11%, reflecting the increase of the 100 basis points of increase in organic growth and the balance from the effects of currency translation. Adjusted earnings per share expectations were raising from $5.45 at the midpoint to $5.55 at the midpoint, which will be 15% growth year-over-year. And when I think about putting this year's progress and perspectives, our original fiscal 2018 guidance provided in November assumed 4% organic growth and $5.23 of adjusted EPS. And the increase we are announcing today reflects operational execution as we move through the year. So if you could please turn to Slide 4, and I'll cover our order trends that we're seeing in detail.

As you can see from the slide, we continue to see broad-based strength in orders across our

3 segments, and this reinforces the growth outlook that we're announcing today. Total orders, excluding SubCom, exceeded $3.6 billion, with a book-to-bill of 1.03. Orders were up 16% year-over-year on a recorded basis and up 6% organically. Geographically, excluding SubCom, our organic orders growth was driven by strength in Europe and the Americas with 6% and 14% growth, respectively. Turning to orders by segment. In Transportation, orders increased 7% organically, with growth in all businesses and strength in Europe and the Americas. Industrial orders grew 5% organically year-over-year, with growth across all regions and strength in our aerospace, defense and industrial equipment businesses. In Communications, excluding SubCom, we saw year-over-year organic order growth of 6%, with growth across all regions and businesses. In our SubCom business, we continue to see an elongated cycle as we booked over $200 million of orders for new projects in the second quarter. And this brings our year-to-date bookings over $600 million and total backlog above $1 billion.

So let me get into the segment results, and we'll start on Slide 5 with Transportation. Transportation sales grew 10% organically year-over-year, with strong growth in each of our 3 businesses. Adjusted operating margins were 20%, as we expected, up 80 basis points year-over-year. Our auto sales were up 7% organically. In the second quarter, global auto production was essentially flat, which was weaker than we anticipated due to the reported production declines that occurred in Korea. Our strong growth above the market in the quarter continues to illustrate the positive impacts of content growth in our auto business along with the benefits of our global leadership position. We had 11% organic growth in auto, both in Europe and in the Americas, where we're benefiting from new product cycle launches as well as share gains We saw low single-digit organic growth in Asia. In China, our organic growth was 9% in the quarter, reflecting our continued strength and leadership in this market. And this was partially offset by the softness in Korea that I just mentioned. Our performance continues to reflect content growth from secular trends in the auto market, and we expect to benefit as the adoption of increases for connected cars as well as electric vehicles increase. TE is extremely well positioned with leading-edge solutions and wins across all global OEMs. In our commercial transportation business, we continue to outperform the market with organic revenue growth of 24% year-over-year, with balanced growth across all regions and strong growth within each sub-market. We continue to see momentum in heavy trucks as well as growth in the agriculture, mining and construction markets. In Sensors, our business grew 8% organically year-over-year with growth across auto, commercial transportation and industrial applications. This growth is driven by the design wins we've been discussing with you over the past 2 years, and we continue to see strong design win momentum, particularly in auto applications. Since the beginning of 2016, we generated over $1.5 billion of new auto design wins, which include $300 million this year alone across a broad spectrum of auto sensor applications. So let me turn to Industrial Solutions. So if you could please turn to Slide 6, please? The segment sales grew 14% on a reported basis and 6% organically. Adjusted operating margins were 13.9% and expanded 100 basis points year-over-year from operating leverage on higher revenue. As we've discussed at our recent Investor Day, we're on a multi-year journey to reduce our factory footprint and lower expenses to expand operating margins in the high-teens in this segment. So please let me highlight some performance by business in this segment. In industrial equipment, organic growth was 9%, with growth across all regions and strength and factory automation. Our strong position in high-growth applications, such as robotics and servo drives, coupled with the acquisitions in these areas, are driving strong growth ahead of the market. In our Aerospace, Defense and Marine business, we saw 5% organic growth, driven by both commercial aerospace and defense. We also saw double-digit growth in commercial air orders, positioning us for growth in this business going forward. And lastly, our Energy business declined slightly on an organic basis, driven by -- primarily by weakness in Europe and partially offset by strength in the Americas. So if you could please turn to Slide 7 and let me cover Communications. As I said earlier, the segment grew 1% organically, which was in line with our expectations. Our Data and Devices and appliance businesses had very strong growth in the quarter with above company average organic growth of 10% on a combined basis. Data and Devices grew 7% organically, with growth across all regions, driven by high-speed connectivity and data center applications as we continue to benefit from our position with hyperscale customers. Appliances continued its strong performance with 14% organic growth and double-digit growth in all regions. We continue to benefit from secular trends, including safety, efficiency and miniaturization as well as our leading global position driving share gains. Adjusted segment operating margins were 11.3% in the quarter. And as we discussed last quarter, we expect this segment to continue to run below our expected mid-teens operating margin due to the delayed SubCom program ramp and the project accounting nature of this business. So with that, let me turn it over to Heath who'll get in the financials in more detail.

Thank you, Terrence, and good morning, everyone. Please turn to Slide 8, where I will provide more details on the Q2 financials.

Adjusted operating income was $635 million with an adjusted operating margin of 17%, leveraging a strong organic growth of 7%. GAAP operating income was $624 million and included $6 million of restructuring and other charges and $5 million of acquisition charges. For the full year, I continue to expect restructuring charges of approximately $150 million, driven primarily by activity in our Industrial Solutions segment as we optimize the footprint and make structural improvements in SG&A across the company. Adjusted EPS was $1.42, up a very strong 19% year-over-year, driven by sales growth as well as the benefit from currency translation. GAAP EPS was $1.39 for the quarter and included restructuring and other charges of $0.02 and acquisition-related charges of $0.01. The adjusted effective tax rate in Q2 was 17.7%. We still expect a full year adjusted tax rate at the lower end of the 19% to 20% range, consistent with our expectations last quarter. However, the year-over-year impacts are more pronounced in the second half versus the first half. While the year-over-year impact of tax is only $0.01 in the first half of this fiscal year, we expect a more significant headwind of $0.07 in the second half due to the difference in the adjusted effective tax rates. Page 15 of our slide deck contains a bridge that provides these details. Turning to Slide 9. Adjusted gross margin in the quarter was 33.2%, with the year-over-year decline driven primarily by the SubCom program delay that we discussed earlier. Despite the gross margin decline, adjusted operating margins expanded 20 basis points to 17% in the quarter. We reduced operating expenses by 130 basis points as a percentage of sales in the quarter, primarily driven by reductions in SG&A. Expense reduction is one of the levers we're pulling to expand operating margins. In the quarter, cash from operations was $377 million and free cash flow was $234 million. In the quarter, we returned $309 million to shareholders through dividends and share repurchases. We expect second half cash flow to accelerate significantly in line with typical seasonality, primarily due to working capital requirements. Also the pipeline of organic growth opportunities continues to be very attractive use of our cash. We have modestly increased our capital investments to be approximately 6% of sales this year to support these growth opportunities. As you know, organic growth has the highest return on investment for the company. We've included the balance sheet and cash flow summary in the appendix for additional details. And with that, I will now turn it back to Terrence.

Thanks, Heath. And let me get into guidance, and I'll start with the third quarter on Slide 10. For the third quarter, we expect revenue of $3.65 billion to $3.7 billion and adjusted earnings per share of $1.35 to $1.37. At the midpoint, this represents reported sales growth of 9% and organic sales growth of 5%, with adjusted earnings per share growth of 10%. If you bridge between the 9% total growth and the 5% organic growth, we expect 300 basis points of that growth driven by currency translation with M&A contributing the rest, which is about 100 basis points. On a dollars basis, year-over-year currency exchange rates are a tailwind of $120 million in the quarter and $0.05 and the tax rate is a headwind in the third quarter of $0.03 that Heath just talked about.

By segment, we expect Transportation Solutions to grow mid-teens on a reported basis, which includes the acquisition of Hirschmann, a leading provider of antenna technology and products that we acquired late in 2017. On an organic basis, we expect high single-digit growth in transportation. We expect auto to be up high single digits organically without performance once again versus market due to content growth. We also expect continued strong growth in commercial transportation and sensors. In Industrial Solutions, we expect to grow mid-single digits organically, with growth driven by continued strength in industrial equipment as well as growth in commercial air and defense. And in Communications, we expect Communications to be down mid-single digits with continued above-market growth in both D&D and appliances being more than offset by declines in SubCom. I do want to highlight SubCom had a very strong quarter over the last quarter (inaudible) , so some of it is due to the comp.

Now turn to Slide 11, so I can cover the full year guidance for 2018. We expect full year revenue of $14.5 billion to $14.7 billion, representing nearly $1.5 billion of increased revenue year-over-year. Let me break that down a little bit. The components of the $1.5 billion of our growth is $800 million of organic growth, $200 million from M&A as well as a $500 million benefit from currency translation.

Versus our prior guidance, revenue is up $400 million at our midpoint and adjusted earnings per share is up $0.10 to $5.55. At the midpoint, our guidance represents reported sales growth of 11% and organic sales growth of 6%.

Adjusted earnings per share growth is expected to be 15% at the midpoint, driven by a flow through in our sales growth as well as the benefit of currency translation. And similar to what Heath just mentioned, I do want to highlight that a higher year-over-year tax rate does negatively impact adjusted earnings per share by $0.08 for the year.

Let me provide some more color on the segments and the full year guidance. We expect Transportation Solutions to be up in the high-teens on a reported basis and up high single digits organically on an assumption of approximately 2% global auto production growth. Our outperformance reflects continued content growth and share gains in auto. We also expect commercial transportation to continue to outperform its end market, and we expect continued growth in our sensors business.

Industrial Solutions is now expected to be up high single digits and organic growth at mid-single digits is unchanged from our prior guide. The primary growth drivers that we're seeing for the year will be the industrial equipment area as well as defense.

And in Communications, we expect to be down low single digits on both a reported and on organic basis, with growth in Data and Devices and appliances being more than offset by declines in SubCom. We now expect SubCom revenue to be in the range of $700 million to $750 million due to the ripple effect of the program delay that we highlighted last quarter. We do expect high single-digit growth combined for Data and Devices and appliances for the year.

In summary, I continue to feel very good about our performance and ability to drive results in line with the business model we shared with you in December. The 6% organic growth and strong double-digit earnings growth of 15% expected this year, we feel, demonstrates it. We have built a portfolio with clear competitive advantages, and you're seeing the benefit of our leading positions and content driving growth above markets that we play in. We are well positioned in large markets with favorable secular trends, and our updated guidance for '18 indicates further growth above those markets and earnings per share expansion, driven by multiple levers.

And finally, I do want to thank our employees across the world for their execution in this past quarter as well as their continued commitment to our customers in a future that is safer sustainable, productive and more connected.

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

All right. Thanks. Brad, can you give the instructions for Q&A session?

(Operator Instructions) And we'll go to the first line, and question will come from Craig Hettenbach with Morgan Stanley.

Just wanted to start with SubCom. And you guys had talked about the expected weakness there. But just from a visibility standpoint and accounting standpoint, when you expect to see some improvement both in revenue and in margins in the SubCom piece?

Craig, thanks for the question. When you think through SubCom, we highlighted last quarter about the program ramp delay we have. We still feel we're in an elongated cycle, and I think we're going to show that. At the company level, and I think you see it in the Communications segment, margins, if we didn't have the program ramp delay, the segment margins would probably be about 200 basis points higher and overall operating margins of the company would probably be about 50 basis points higher. So that sort of qualifies what we're working through. As we all know in SubCom, SubCom has anywhere from 4 to 6 projects going on, and this is one of them. So we do expect that this will be -- the program just due to how its project accounting will work through as the project completes, so we do expect that for the rest of the year. But the backlog makes us feel very good about the cycle, and we just have to work through this one program issue. So market feels good, our ramp for winning feels good. We just have on the margin side this pressure from this ramp delay we're dealing with.

Great. Thanks for the color on the margins, in particular. And then just on the automotive sensor side, in terms of some of those design win, can you talk about when you see an inflection in the revenue, like from a timing perspective, when these wins will start to ramp?

Well, as we all know, in automotive -- what's great about automotive is, as you win these, they layer in. And we're starting to see that. As we said, later this year, we expect it to be grow in double digits. And our automotive sensor piece of our sensors business, we are still committed to that. You're going to continue to see strong growth as these design wins come into revenue. So I think it's really creating a good backbone. I think you're seeing broad growth in the sensors business. And I feel very good that our automotive sensors business, actually in the quarter, grew higher than our automotive connector business, which is a real first. I think those indicators that we've put out there for you, starting second half grow in double digit, we feel very good about it and it will continue to layer in over time and get some of the return on the investments we've made.

All right. Thank you, Craig. Can we have the next question, please?

Will come from Wamsi Mohan with Bank of America.

So Terrence, when you net everything out, there is an implied $0.05 -- there's a $0.10 increase in your guide for the full year, but a $0.05 lower operational performance, relative to prior expectations. Can you clarify how much of this is the SubCom shortfall? And is your view on SubCom, it doesn't sound like it's really changed longer term, given the strong backlog, but just wanted to get some color on that? And Heath, could you comment on the weaker gross margins and free cash flow. If you could bridge those on a year-over-year basis? Should we expect a substantial jump up in the second half, both half-over-half and year-over-year?

Wamsi, I'm going to take -- I'll add on to what I said to Craig about SubCom, and I'm going to ask Heath to talk about the EPS comment as well as the margin and free cash flow. So when you look at the order momentum, it's the trends we talked about and the $1 billion of backlog that we have and the $600 million we booked. So long-term trends, I do not see it's really around -- the backbone is really -- that supports the video demand that continues to get pulled. And certainly, our customers are the hyperscale here, so I feel good about the momentum there. And then Heath, why don't you take the second piece?

Yes. The year-over-year decline in gross margin is primarily due to SubCom and some of the pressures that we're working through relative to that project. As you know, in the project accounting world, it's is not a 1-period impact as it spreads through the entire time frame of the overall project, which will take us into the early part of 2019. Having said that, we would expect to start to see some improvement in the overall margins, both in that segment level as well as in SubCom itself as we continue to work our way through that into the early parts of next year. On the cash flow side. Cash flows, in the -- we're year-to-date about $400 million -- little over $300 million in cash. I would tell you that we have built up some inventory to support the growth in the second half of the year. And we would expect that operating cap -- working capital would move from use of cash to a source of cash as we move our way through the second half of the year. We've got pretty good line of sight to that.

And (inaudible) we will go to next question that comes from David Leiker with Baird.

On the transportation business, now that you clearly have a lot of secular trends there that you have as tailwinds through your business there in terms of driving bookings. If we look at the business that you're seeing coming in right now for new contract awards, are there any particular things there you'd call out that show either higher take rates or increased technology -- different technology that are coming to market, anything in particular, that seems to be gaining more strength relative to over the last year or 2?

David, it's a great question. And what I would say is, you really see every OEM really focused on anything connected as well as the powertrain on the electric side. So I would say those trends are not new. I would say, there continues to be an acceleration on the powertrain side. I would say that side is one that we continue to see increased demand. Now as you know, what we win today doesn't turn into revenue for 4 years, but I would tell you, our TERP, or revenue pipeline that we had, and I quoted at sensor, we continue to see increased TERP momentum both around connected and electric powertrain, whatever piece it is, whether it's plug-in, whether it's hybrid. So those are things we continue to see in all regions of the world. And when you think about where we're positioned, we feel very good that we can -- we get the benefit of both of those. So I wouldn't say it's not something significantly different, we're just continuing to see that strong acceleration across both of them.

Okay. Thank you, David. Can we have the next question, please?

Sure. That will come from Shawn Harrison with Longbow Research.

I'm going to beat the SubCom issue to death if I can. If we look into 2019, is there an expectation that you would see kind of a rebound into the $800 million to $900 million of annual revenue range? Or is it more trending toward kind of this lower level for the next 18 months?

Shawn, I think, we're -- first of all, 2019 is too early to tell as the projects stack themselves up. The backlog is good and our visibility out is good. I don't want to quantify that. I think staying in that range that we talked about at our Analyst Day in December, which was $600 million to $1 billion, we're comfortably inside that range. Certainly, this year, we'll be somewhere between $700 million to $750 million. I think, as important that we're going to see margin momentum as we go into next year as we wean ourself off of this particular -- the single project delay. So we're going to sidestep part of your question in terms of quantifying it. But I would say that the backlog is setting up nicely.

Our next question will come from Amit Daryanani with RBC Capital Markets.

I guess, maybe to start with Industrial segment. Could you just maybe help me understand how much cost -- how much costs are you taking out of the model right now from all these cost containment initiatives? And should revenues remain stable to where they're today, what could fiscal '19 margins look like on the industrial side? Just want to get a sense of what the cost-containment benefits would be? And then secondly, just on the Subsea thing. I understand all the issues you guys are outlining right now, but these are all the same issues, it sounds like, you knew about 90 days ago when you initially talked about this pushout. So what's really changed in the last 90 days for margins to take a hiccup and for you to lower your full year revenue expectations from Subsea?

Go ahead.

Yes. No, so I'm going to take the second part and I'll let Heath do the Industrial. Number one is, it's just slightly less than where we were on SubCom, and it really relates to the program delay we knew about, but it is creating some ripple effect because realize, we have 1 factory, 1 engineering team and that's creating a bump effect on other projects, and we're working through that. So when you look at it, revenue is down slightly and margin's down slightly due to that revenue. So that's really all that's changed. And then on the Industrial segment...

We're still -- we've talked pretty openly about the footprint consolidation activity that is taking place in our industrial business. We are still -- the programmatic element of that, some of the bigger moves, we are still in fairly early days of that. As we talked about in last couple of quarters, that's something that's going to transpire over the next several quarters -- over the next couple of years. So I would tell you that the margin improvement that you're seeing is both good operational execution by the team, some moderate restructuring as well as good leverage on the organic revenue growth. As you think about 2019, we're -- we're getting a lot of '19 questions today already, with 2 quarters left in our '18 fiscal year, but I would tell you that whatever organic revenue growth that you want to model for Industrial, using a normalized flow through of 25% to 30%, I think, is probably good modeling. And we'll be more -- we'll have more clarity as we progress through the end of the year or how much of the impact of the restructuring the larger projects that will layer into next year, both on the cost side as well as the savings side.

All right. Thank you, Amit. Can we have the next question, please?

Sure. That will come from Mark Delaney with Goldman Sachs.

I was hoping you could help better contextualize the revenue guidance for the June quarter on a sequential basis? Certainly appreciate the much higher base in March. And you mentioned some Subsea issues, but even putting Subsea aside, it seems like a below seasonal sequential guidance for June. So is that just conservatism or are there any markets where you're expecting deceleration in June on a quarter-to-quarter basis?

We're -- yes, this is Heath. We're expecting the second half of the year to be about 3% organically higher than the first half of the year. How it calendarizes between our third and our fourth quarter is, there's always puts and takes in terms of how -- what activity is going on. But in terms of where our order's stacked up towards the end of our second quarter as we lean into the third quarter in our 5% organic growth guidance, we feel pretty good about that number. And we'll update you in 90 days in terms of where we ended up.

Okay. Thank you, Mark. Can we have the next question, please?

Sure. It'll come from Christopher Glynn with Oppenheimer.

So for the current year transportation group, got a great test case to really see the content growth and the outperformance versus the cycle. At Industrial, it's a less clear test case because it's good industrial cycle there. But just wondering if you could speak to the kind of long-term qualitative visibility of that segment for outgrowth with the factory automation, et cetera, in relation to the much established understanding of how transportation should perform long term?

Thanks, Chris, for the question. Let me take that. So first off, when I think through transportation, before I get to Industrial, I think it's more than just this year is proved outperformance. Last year, in a 3% production environment, we grew 10%. And this year with a 2%, we're growing high single digits. So I think, we continue to show that in a production cycle, that is decelerating in automotive, and I think you see that. In industrial, I think, it will always be a little bit murkier because you don't have one index, you really have industrial production. And I think you're seeing at that 6% good performance. And I think the drivers of it, as we talked about Investor Day, are really 3 elements: number one is the commercial air platforms that we've talked to you about where we have significant content increases with both major airframe suppliers and while we had a bump in our bookings for the past 6 months or so as you're starting to see that reacceleration on those take rates. Secondly is where we position ourselves in factory automation, you mentioned robotics. There is increased content. And when you're looking at the connectedness in the factory, the digitization of the factory, that clearly plays where we are. And then the third area that I would say, long term, will drive it is also our medical business. Our medical businesses in there, that's long-term high single digit with where we've done things around therapies and around structural heart. So those are the 3 major drivers long term. The other thing that we're benefiting from near term is defense. Defense, we have seen a tick up over the past 6 months. We've highlighted it this year. But that is something we sort of view it is only going to be around budget cycles. But that's the way we think about Industrial and why we feel in an industrial production environment that typically is below GDP, we can grow that mid-single digit like we're showing this year.

Okay. Thank you, Chris. Can we have the next question, please?

Sure. And our next question will come from the line of Joseph Giordano with Cowen.

So kind of related questions here. You mentioned robotics. I don't remember you mentioning that recently. Can you kind of talk about where you're seeing strength there? Is it a particular application or particular market within that? And then kind of related, curious for some -- an update on how you're seeing the Integrated Solutions between connectors and sensors together? Are you making that combined sale like on an engineer kind of level?

Yes. So let me take both of them. They're very different questions. No, on robotics, we did talk about it at Investor Day. And what we see there: number one is, it leverages not only what we do, but also our global position. So we benefit from both the robotics manufacturers in Japan as well as increasingly in China as well as the traditional robot manufacturers that you can have in Germany and Europe. So we're very well positioned at all of those, and it's really across board applications. We see it in automotive. As you still get program ramp ups, we're are also seeing it increasingly everywhere globally as people deal with labor and how do they get better quality and productivity. So we continue to see that, and that is where we're benefiting from. On the Solutions side -- your second part of your question, on the Solutions side, we continue to see it -- the strongest we see it is more around our automotive, where we have a very strong position. Elsewhere, I would say, it's more spotty, but we continue to have momentum in the TERP and the revenue pipeline we have, but clearly, we do get those benefits similar to the examples we've shown everybody. That does not only give us sensor opportunity, interconnect opportunity, it also takes content up overall because there's other things that we do when we provide more of that solution. So that is part of the content story when you look at automotive and you see that separation. And we also have that in our industrial transportation business, you see it. In our commercial transportation business, you see tremendous growth. That has not only rebound in the market, that is also on the solutions that we're doing everywhere in the world, not just in one region. It's benefiting in China, it's benefiting here and you really see it in the outperformance that we had. It's now been well over 1.5 years in that business.

Okay. Thanks for the question, Joe. Can we have the next question, please?

Sure. That will come from Deepa Raghavan with Wells Fargo Securities.

A couple for me. Could you please talk about China momentum across your product lines? Exactly where you're seeing some strengths and some weaknesses? Looks like lot of story is accumulating there. You mentioned robotics, what else? And secondarily, Heath, could you comment on the inventory in the channel? Mixed reads there, but sales have been pretty strong.

Thank you, Deepa. So let me take the China piece, Heath will take the inventory piece. So on China, our performance was very strong in the quarter. Our sales growth overall was basically 10%. And when you see that in Transportation, not just auto, across, we were up 12%. In our Industrial business unit where we have robotics, we had 10% growth as well as in our Communications Solutions, which is both Data Devices and appliances, I'm excluding SubCom, we were up 8%. So very strong growth across the China verticals, not just in one application. So feel very good about the momentum we've had in China. And certainly, that's higher than company organic growth. So I'll hand it over to Heath here that will talk about inventory channel.

Yes. The channel inventory actually is -- as you can imagine, you've seen the numbers in our Industrial Solutions segment, is benefiting greatly from that. If you look at -- there's -- we feel very good that there's not a buildup in the channel inventory. Our channel partners have confirmed that. We've got pretty good line of sight to our major channel partners in terms of what they're stocking right now. And that continues to be pretty strong and a good indicator for us in terms of the broader industrial economy. So in general, in good shape.

All right. Thank you, Deepa. Can we have the next question, please?

And that will come from Jim Suva with Citi.

On the SubCom, it sounds like, has the pushout been elongated even further than what you'd thought, say 90 days ago. And are you losing any business or -- to customers -- competitors who maybe want solutions or contract completed sooner?

Jim, with the orders we see, we don't believe we're losing contracts. In fact, the $600 million we feel very good about where we are year-to-date from the backlog perspective. It is just one project, a program delay. It's a little but -- so it's about $50 million as we highlighted in our guide. But from that viewpoint, something we'll work through. We have to remember this is a construction business, so it does create some ripple effect. And these are typically long-term projects to begin with. Typically, these projects get worked on, get won. They don't start construction right away. So I don't feel we're hurting any customer on other projects through it. It's just that how we're planning through it and how we have to run the cable through the factory and integrate it for the deployment because this is a complete system. Realize, we do the design work at the system, we do the manufacturing of the equipment that goes in the system and we deploy it. So it's a turnkey solution and guess what, when we give a turnkey solution, we're going to give a solution that works to the expectations our customers have at it. And really in this case, we're making sure we're going to keep our customers happy.

Okay. Thank you, Jim. Can we have the next question, please?

And that will come from Steve Fox with Cross Research.

Just one on capital spending. So Heath, you explained the cash flow dynamics for second half. But with the increase in capital spending through the year, could you just give us a sense for the -- what the spending is directed at and whether this is a change in your long-term expectations for CapEx ratios?

Sure. And Steve, I appreciate the question. Regarding CapEx, we are running higher this year than we have in the past. And I will tell you that as we evaluate our opportunity set there, it's really very strong and it's all tied to growth. It's in the areas that you would expect us in the areas we've highlighted around auto wins, things in the sensors world, things in the medical world, selectively across industrial, where we have won projects and we're in the process of tooling up for those. And in this business, sometimes you're spending money to get tooled up and so forth, sometimes 1 to 2 years in advance of when you'll actually see the revenue. And we talk a lot about something called the TERP, which is the TE revenue pipeline. And in these businesses, that I mentioned, the opportunity set is very strong. These are largely things that have been committed by customers that will fuel organic revenue growth, outsized organic revenue growth for time to come. So as we look at it -- in the use of our cash flows, this is a really good opportunity to step that up because the return on invested capital from these investments is quite good. Now we'll always be good shepherds of the cash and disciplined with where we do it, no different than our Q&A -- our M&A activity. But we feel like this is a pretty good step up. If you're modeling it, we're going to run about 6% this year. I'd say it's hard to know because as the markets correct or move around, we might adjust our thinking there. But we've probably pivoted -- if you're modeling between 5% and 6%, we've probably pivoted a little bit closer to the higher end of that range. And we'll continue to update everyone as things come around. But this is really exciting opportunity to invest. And I would say our cash flow -- your first part of your question, the cash flow in the second -- in our second half of fiscal year will be significantly higher than what you saw in the first half. And most of that is not tied to a reduction in CapEx, most of that is, you'll see a reduction in working capital as it turns into a source of cash. I would expect our second half free cash flow to be at or higher than what our second half free cash flow was a year ago.

Okay. Thank you, Steve. Can we have the next question, please?

Sure. That will come from William Stein with SunTrust.

One clarification and then one question. Clarification is, again, on SubCom. I understand, there's lot of leverage in that business, but there's also this unusual project accounting. If revenue were to not rebound from these levels, would margins increase regardless because of the accounting treatment? And then I had a question about supply chain. You had some issues here that hurt profitability, I think, last year. I don't think those are happening now, but there are broader issues in the supply chain with regard to passives and discrete semis. And I wonder if you see any impact of that on the business?

I'll take the first part of the question and Terrence will chime in for the second half. Relative to the percentage of completion accounting that is handled by the SubCom team for these projects, it is very specific project by project. So not all projects are created equal in terms of size of project or implied margin of those projects. So when you have hiccups, whether it's in the factory or when you have any kind of ramp up, otherwise, because of technology or requirements, those tend to bleed through a particular project through the end of that contract as it gets revalued. I would say, if you were looking at it versus raw total top line number for the business, there can be a mix in projects can swing that profitability pretty dramatically. So I wouldn't assume that the business stays at low levels if the revenue does not rebound. Because there are things coming in and obviously we're very conscious of the $1 billion-plus of backlog that we have in the business, what the makeup of the implied margin is in that business, and we would tell you that runs higher than where we are today. But largely because we've had some inefficiencies with this particular project delay ramp up that we're wading our way through now. Terrence?

Yes. And Will, on the supply chain, first off, I would say what we look at the supply chain in our world. We're not a semiconductor, we aren't a passive. There are some extended lead times very much in those product categories. When we look in our world, there are some pockets where lead times extended what I like and Heath talked about a little bit is our sell-in to distribution and their sellout is in parity. So we do not see distributor getting ahead of themselves, so the sell-in and sell-through is in alignment. Certainly, there are some areas, you can see in our growth rates, there are some areas growing 20%. When you have that type of growth, we have extended lead times as we catch up. But I would not say it's broad based like some other product categories that you may follow.

Okay. Thank you, Will. Can we have the next question, please?

That will come from Shawn Harrison with Longbow Research.

Just following up a little bit on Will's question. The margin impact from SubCom 50 -- we think it was 50 basis points corporate overall. Once we get into the middle of the next year, you would expect that to not be a 50 basis point drag from kind of the SubCom. Is that the best way to think about modeling it into '19?

I think that's a fair way of thinking about it, Shawn.

Okay. And then as a brief follow-up just on the Data and Devices business, the hyperscale strength. Are you seeing any change in the composition of the hyperscale guys that are driving your business, maybe more customers, less customers, kind of a slowing growth rate in terms of underlying spend or an accelerated growth rate?

Sure. Shawn, on that, it's the same customers, I would say. I don't see more players and I would say it's been pretty constant. So what's really great is, as you're aware, when you take our Data and Devices business, there's hyperscale customers, there is legacy telecom customers and then there are sort of the lower tier below that. Hyperscale continues a very accelerated growth rate and to have the growth rates that we've talked about, really proud of the team with what the solutions they're bringing on the high-speed area. We do expect, outside of SubCom, high single-digit organic growth really shows the traction have with those customers and stay in front because they do have high expectations, and I think we're doing a good job.

Thank you, Shawn. Can we have the next question, please?

It will come from Sherri Scribner with Deutsche Bank.

Terrence, I'd be curious to get your thoughts on the trade war discussions that are going on about the U.S. and China. I know you guys aren't incorporated in the U.S. and so maybe this has less of an impact on you. But I'm curious given your exposure to China and the Chinese auto market, how do you see potential trade wars potentially affecting your business. I assume it might have some negative impact. And what have your customers said about this?

So Sherri, one of the things -- I think you have to take it back to what our business model is, and it's really staying close to our customers. And we try to localize both engineering as well as manufacturing close to our customers so we can co-create. So we are firmly a believer in global free trade. And we are staying close to our customers because we have to stay to them to what decisions they make, where they want a design as well also where they want their supply chains to be. So that's the way we focus on it to really make sure how do we win with our customers and also how do we support them. So we have not had a lot of feedback from our customers yet. I think there is a lot of -- clearly a lot of words being said and our customers are trying to digest it, and we're staying close to them. So that's really always our strategy in these situations, to really stay close to our customers. And we'll continue to update on our orders and everybody else as we [trim] more, but right now there is really no update.

Okay. Thank you, Sherri. Can we have the next question, please?

Sure. That will come from Joe Giordano with Cohen.

Heath, just given all the questions on SubCom, have you -- how much thought have you guys given to just reporting that as a separate segment so that it doesn't kind of obscure the positive trends we're seeing in the rest of the Communications business?

Well, candidly, not a lot of thought. It's -- I mean, we obviously -- our organizational structure is set up in such a way that it adheres to segment accounting rules and so forth. And the SubCom team is managed by the same team that manages the rest of the organization. So -- rest of the CS business. So -- no, it's not front and center for us. We try to provide as much visibility as we can to explain due to the lumpiness of the business, both from an order as well as a revenue perspective that, that certainly is something we try to highlight there. But pulling it out as a separate segment, I don't see in the near future.

Okay. Thank you, Joe. It looks like we don't have any further questions. So if anyone does have questions, please contact investor relations at TE. Thank you for joining us this morning, and have a nice day.

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