泰科電子 (TEL) 2021 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by, and welcome to the TE Connectivity Second Quarter Earnings Call for Fiscal Year 2021. (Operator Instructions)

I would now like to turn the conference over to your host, Vice President of Investor Relations, Sujal Shah. Please go ahead.

Good morning, and thank you for joining our conference call to discuss TE Connectivity's second quarter results. With me today are Chief Executive Officer, Terrence Curtin; Chief Financial Officer, Heath Mitts.

During 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, and we ask you to review the sections of our press release and the accompanying slide presentation that address the use of these items. The press release and related tables, along with the slide presentation, can be found on the Investor Relations portion of our website at te.com.

Due to the large number of participants on the Q&A portion of today's call, we're asking everyone to limit themselves to one question to make sure we can give everyone an opportunity to ask questions during the allotted time. We're willing to take follow-up questions but ask that you rejoin the queue if you have a second question.

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 results for the second quarter as well as our expectations for the third quarter of our fiscal 2021.

Before I get into slides, let me give you some perspective on our second quarter. And I think as you'll see in our results, we are continuing to demonstrate the strength of our diverse portfolio and the benefit of content growth across our businesses. We are delivering organic growth ahead of our markets as well as strong operational performance and free cash flow generation.

I would say this performance is in a world with an improving economic backdrop that is dealing with global supply chains that are trying to keep up with the broader macro recovery. We are continuing to execute to our business model, and you can see this in our second quarter results as well as the guidance that we provide for the third quarter that I'll talk about a little bit more today.

So let me also provide some key messages about today's call. First off, I am very pleased with our execution in the second quarter. We delivered sales growth of 17% and generated record quarterly adjusted earnings per share of $1.57, and this EPS represents growth of 22% year-over-year. Our sales were ahead of our expectations, and it was broad across each segment, driven by the continued recovery in most end markets we serve, our broad leadership positions and the benefits of the secular trends that we've strategically positioned TE to capitalize on.

Also, our adjusted operating margins expanded 80 basis points year-over-year to 17%, and this was driven by margin expansion in both our transportation and communications segments. I also believe that you're going to continue to see us demonstrate our strong cash generation and truly evident of that is our year-to-date free cash flow, which was approximately $1 billion, which is also a company record for the first half of the fiscal year. And as we look into our third quarter, we are expecting our strong performance to continue, with sales and adjusted earnings per share at similar levels to what we just delivered in the second quarter.

With that as a little bit of a backdrop, I do want to take a moment to frame out the current market environment and our business relative to where we were just 90 days ago when we last spoke. In our transportation segment, consumer demand in autos continues to remain strong, and auto production is remaining stable in the range of 19 million to 20 million units per quarter globally even with the well-documented semi shortages. And we've also seen further strength, [as I said, in] our commercial transportation end markets. The trends around content growth remains strong as we continue to benefit from increased electronification of vehicles and higher production of electric vehicles, which will enable us to continue to outperform auto production going forward.

In our industrial segment, we see increased momentum in the recovery of industrial equipment markets due to factory automation and increasing manufacturing capital expenditure trends. Also in our industrial segment, the commercial aerospace and medical businesses are still being impacted by COVID, and this is similar to what we mentioned last quarter, but we do continue to see indicators of stability in our orders in both of these businesses.

In our communications segment, the market trend we mentioned last quarter are continuing. Consumer demand is getting stronger, and globally, we've seen an increase in appliance demand. We continue to see strong ongoing capital expenditure trends in the cloud applications as well as acceleration of demand around the data center.

And when you think about these trends I just covered in our segments as a backdrop, the faster-than-expected recovery in the markets that I mentioned has resulted in some challenges as the industries we serve replenish their supply chain and look to further secure supply. While this dynamic has benefited our orders, which remains strong, it has caused broader supply chain pressure. And the pressure we're experiencing is factored into our expectations for the third quarter guidance, and Heath will provide more color on this in his session.

And the last thing I want to highlight is let's all remember that we are still in a world that's feeling COVID. We continue to see countries go into lockdown again, and this is impacting some of our customers and their supply chains. And certainly, while vaccines are getting rolled out in certain parts of the world, the pace of the deployment and availability of the vaccines varies greatly by country, so some uncertainty remains. Our focus has been, and will continue to be on keeping our employees safe while also helping our customers capitalize on the improving economic conditions.

So with that as a backdrop, let me get into the slides, and I'd appreciate if you could turn to Slide 3 to provide some additional details for our second quarter and our expectations for the third quarter. Second quarter sales of $3.7 billion were better than our expectations in each of our segments. They were up 17% on a reported basis and 11% organically year-over-year. We had 15% organic growth in our transportation segment with double-digit growth across all businesses. We also had very strong performance in our communications segment with organic growth of 29%, which was strong double-digit growth in both of the businesses in that segment. And in our industrial segment, sales were down 4% organically due to the ongoing weakness in the commercial aerospace market.

From an orders perspective, second quarter orders were $4.6 billion, and this was up 36% year-over-year. It reflects both the improvement in the markets that I mentioned, along with inventory replenishment in the supply chain by our customers.

Our earnings per share was a record at $1.57 in the quarter, and this was up 22% year-over-year and was driven entirely by our operating performance, resulting in adjusted operating margins being up 80 basis points year-over-year. I am pleased that we were able to manage the broader supply chain pressures, which all companies are dealing with and had margin expansion.

From a free cash flow perspective, in the second quarter, free cash flow was $477 million with approximately $340 million being returned to shareholders. As we look forward, we expect our strong performance to continue into the third quarter with sales and adjusted earnings per share being similar to our second quarter levels. For the third quarter, we expect sales to be approximately $3.7 billion and this is up significantly year-over-year on both a reported and an organic basis. And we expect adjusted earnings per share to be $1.57, which is in line with the levels we just saw in the quarter we just closed.

So let's turn to Slide 4, and I'll cover the order trends that we're seeing. As I already stated in the quarter, our orders were very strong at approximately $4.6 billion, and we had a book-to-bill of 1.22. Orders in transportation and communications were up 50% and 45%, respectively. And this increase reflects both market recovery and supply chain replenishment in both of those segments.

In these segments, customers are not only placing orders to meet current production needs but also replenishing the supply chains that were depleted during fiscal 2020. I would also highlight that with some of the shortages in semiconductors and certain passive components, we are seeing some areas where customers are placing orders to secure supply beyond our lead times.

In our industrial segment, it is a different picture than what we're seeing in transportation and communications. But what is nice is that despite the year-over-year sales decline we had in this segment, we have seen orders growth of 7%, and that's driven by the continued recovery in the industrial equipment market, partially offset by the weakness in commercial aerospace that I mentioned.

Let me also, on orders, add some color on what we're seeing organically on a geographic basis, and I'm going to do this on a sequential basis to show where order momentum is. In China, our orders were up 3% from a strong base from fiscal quarter 1. And that growth was really driven by our industrial and communications segments. Orders on a sequential basis in Europe were up 14% and North America sequential orders were up 22%, and that was broad-based growth across all our segments in those 2 regions.

So let me get into our year-over-year segment results, and they're on Slides 5 through 7. I'm going to touch upon each segment briefly before I turn it over to Heath. Transportation sales were up 15% organically year-over-year with growth in each of the businesses. In auto, our sales were up 14% organically, and year-to-date, we are generating content outperformance over production in our expected 4% to 6% range. We continue to benefit from our leading global position and increased production of electric vehicles. And as you've probably seen, the number of EV launches are increasing by our customers around the world.

In commercial transportation, similar to our first quarter, we saw 25% organic growth driven by ongoing emission trends, content outperformance and ongoing share gains. We are continuing to benefit from stricter emission standards and the increased operator adoption of Euro 5 and 6 in China, which reinforces our strong position in that country. We saw growth in all regions in our commercial transportation business, along with double-digit growth in all market verticals that we serve in this business. The other nice thing that we continue to see is we see increased wins on electric powertrain platforms and trucks, which give us confidence about the future content potential in this market, in out years.

In our sensors business, we saw 13% organic growth with growth in all markets and double-digit growth in auto applications. We do continue to expand our design win pipeline in auto sensing and expect growth as these platforms continue to increase in volume. From a margin perspective, adjusted operating margins for the segment expanded 80 basis points to 18.1% driven by higher volumes versus the prior year and despite the supply chain pressures.

So if we now turn to the industrial segment. As I said earlier, our sales declined 4% organically year-over-year. During the quarter, the segment continued to be impacted by the decline in the commercial aerospace market with our aerospace, defense and marine business declining 21% organically year-over-year. As I covered already, based upon the order patterns, we do believe this business is showing signs of stabilization at the current order levels.

And when you think about our industrial equipment market, it was very strong and up 16% organically, with growth in all regions and increasing strength in factory automation applications, where we're benefiting from accelerating capital expenditures in areas like semiconductor equipment as well as along the auto manufacturing supply chain. We continue to see weakness in our medical business in our industrial segment, and it was down 13% organically year-over-year. And this is being driven by ongoing delays in interventional elective procedures caused by COVID. And the dynamics we're experiencing in medical are consistent with what our customers are seeing, and we expect this market to return to growth as these procedures start to increase later in the year.

And lastly, in the industrial segment, our Energy business, we saw 4% organic growth, and this was driven by increase in penetration of renewables, especially benefiting from solar applications around the world. From a margin perspective in Industrial Solutions, our margins declined year-over-year to 12.5%, and that was really driven by the significant drop in commercial aerospace volumes.

So let me cover the communications segment. And in this segment, we continue to benefit from both the market recovery and share gains while delivering very strong operational performance. Sales in the segment grew 29% organically year-over-year with strong growth in both data and devices and appliances.

In data and devices, our sales grew 24% organically year-over-year due to the strong position we have built in high-speed solutions for cloud applications. Favorable secular trends in cloud services are leading to increased capital expenditures by our customers, and our content and share gains are enabling us to grow on cloud-related sales at double the market rate.

Just to give you an example, at one of the major cloud providers, we are now providing 6x the content on the next-generation server applications versus the prior generation. In our appliances business, we are also seeing strong growth trends. Sales grew 35% organically year-over-year, driven by our leading global market position, share gains and ongoing market improvement across all regions.

From a margin perspective, our communications segment and team delivered very strong execution in the quarter, and it delivered 21% adjusted operating margins, and these were up 720 basis points versus the prior year. I am pleased with the way our team has worked through the supply chain pressures to deliver these strong operating margin expansion in this environment, and our communication teams are capitalizing on growth trends in their end markets, while delivering strong operational execution, and you see this reflected in our results.

So with that, let me turn it over to Heath to get into more details on the financials and our expectations going forward.

Well, 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 $637 million, up approximately 23% year-over-year with an adjusted operating margin of 17%. The GAAP operating income was $612 million and included $17 million of restructuring and other charges and $8 million of acquisition-related charges. We continue to optimize our manufacturing footprint and improve the cost structure of the organization and continue to expect total restructuring charges in the ballpark of $200 million for fiscal '21.

Adjusted EPS was $1.57 and GAAP EPS was $1.51 for the quarter and included restructuring, acquisition and other charges of $0.06. The adjusted effective tax rate in Q2 was approximately 17%. For the third quarter, we expect our tax rate to be up slightly sequentially and continue to expect an adjusted effective tax rate around 19% from fiscal '21. Importantly, we expect our cash tax rate to stay well below our reported ETR for the full year.

Now turning to Slide 9. Sales of $3.7 billion were up 17% versus the prior year and 6% sequentially, demonstrating the strength of our portfolio. Currency exchange rates positively impacted sales by $150 million versus the prior year. Adjusted EPS of $1.57 was up 22% year-over-year and 7% sequentially, reflecting our strong operational performance.

Adjusted operating margins were 17% and expanded 80 basis points versus the prior year. While we would have expected higher fall-through on this level of sales growth, we saw impacts of higher freight charges and other supply chain pressures in the quarter, and these will continue into the third quarter.

And as you are aware, these supply chain issues are having a broader impact on our customers and suppliers as well. As Terrence mentioned, the supply chain is catching up to the increased level of demand we are seeing in many of our end markets. And given these dynamics, I'm pleased with the results we delivered in the quarter and of our momentum going forward, as shown in our third quarter guidance.

In the quarter, cash from operating activities was $580 million. We had very strong free cash flow for the quarter of $477 million, and the year-to-date free cash flow was approximately $1 billion, which is a record for the first half of the fiscal year. We returned approximately $340 million to shareholders through dividends and share repurchases in the quarter.

Our strong free cash flow performance demonstrates the strength of our cash generation model, and we expect to -- and we continue to expect free cash flow conversion to approximate 100% for the full year. We remain committed to our disciplined use of cash, and over time, we expect 2/3 of our free cash flow to be returned to shareholders and 1/3 to be used for acquisitions.

Before we go to questions, I want to reiterate that we remain excited about how we have positioned our portfolio with leadership positions in the markets we serve, along with organic growth and margin expansion opportunities ahead of us. To summarize, the outlook for many of the markets we serve is consistent with what we are seeing 90 days ago, along with some acceleration of growth in the commercial transportation, industrial equipment and communications markets.

We are continuing to see the benefits of secular trends across our portfolio and are capitalizing on these opportunities. The economic recovery has been faster than expected, and we are seeing the corresponding near-term pressures in the broader supply chain as a result. These impacts will be resolved, and nothing has changed with respect to our growth and margin expansion expectations.

We are executing well on the things we can control, and our outlook in Q3 continues to reflect the strength of our portfolio. We expect to continue to generate strong free cash flow, maintain a disciplined and balanced capital strategy and drive to our business model performance. And we remain focused on value creation for our stakeholders going forward. Now let's open it up for questions.

Okay. Thank you, Heath. Michelle, could you please give the instructions for the Q&A session.

(Operator Instructions) And your first question will come from Craig Hettenbach from Morgan Stanley.

Question for Terrence. There are a number of references to replenishment on the call. So can you just talk about the strength you're seeing in the business, when customers you think will get caught up on inventory and importantly, the type of sell-through you're seeing.

Sure. Thanks, Craig. And let me -- you see that in our orders. And I think one of the things is we're all dealing with a recovery across those markets that are seeing that improved recovery at a faster rate than we all expected, and inventory levels are low. When we see the orders perhaps that we see, we do see people trying not only to make -- get the products in for what they want to make but also to get the supply chains up that ensure that there are on some of the stresses that we hear about in other components.

So when you look at that, I think we're all in the middle of that, real time. These are stresses that you get when you have a recovery that's in motion. I do think we need a couple of quarters for that to play out, because it is pretty broad-based, and stocks were taken very low. And even when you think about our channel partners, our channel partners are holding churn levels that are lower than normal, and they're trying to catch up. So it is very broad across those markets that you see the strength in, and it will take a couple of quarters to get truly everything probably replenished.

Your next question comes from Wamsi Mohan from Bank of America.

Terrence, you alluded to a few things within the communications segment performance. Can you remind us how much of that is cloud now? And are you expecting this growth to sustain here? And how sustainable are these margins?

Yes. Thanks, Wamsi. In communications, I think one of the things that we have to keep in front of us is it was our segment that was least impacted last year. And so I think that even makes when you look at the results that segment have -- or more impressive because they didn't have the dip that our transportation segment had when the Western world shut down auto production.

And so the growth that you see, first off, is in D&D, it is primarily driven by cloud applications. And I think it's both the acceleration of cloud CapEx in addition to where we position ourselves from a market share perspective, and we continue to do a nice job in that team, continuing to build more momentum from a share perspective, and that's really driving that growth.

The other thing that you have in that segment is our appliance business has a great global position. And we're also benefiting from as certainly appliances have accelerated globally around the world. You're seeing the benefit of that business. And you're also seeing how globally the businesses are. So certainly, I talked about it in orders, but these businesses are very globally balanced. And you're seeing the growth.

So I feel good about the positioning we've done on the top line. I would also say with the volumes that we're at, we would expect that this segment would be higher margin than what we told you historically. So we always said this is probably middle teen. At these types of levels, you'd probably be in the middle higher teens over time. And it just shows that the work that we've done to improve the portfolio here, the trends we've put it around as well as the operational execution the team has done. So thanks, Wamsi, for the question.

Your next question comes from Amit Daryanani from Evercore.

Terrence, I was wondering if you would maybe reconcile the deviation between the strength we're seeing on both the book-to-bill and the auto numbers that you put out versus the June quarter guide, right? I mean, if I think about the book-to-bill of 1.22 I would have thought June '20 guide would be north of $4 billion in revenue. So I'd just love to understand what's the delta between the book-to-bill versus your guide. And related to that, the auto strength you're talking about, is there any deviation between channel versus OEM there?

So yes, let me just take it -- I'm going to take your last piece first, if that's okay. Yes, when you look at it, the trends where you're seeing the acceleration in, also with some of the supply chain stresses, you do see orders in the channel were probably a couple of hundred million higher than what we built. And our channel sales grew similar to what the total company grew.

So you do see our -- the channel partners trying -- their inventories are low, they're trying to catch up. But I would say it's different than what we're seeing direct. It is about how do we make sure the supply chain levels to support this fast recovery get into place. When you look at our book-to-bill of 1.22, as you all know, this is not a business that's typically a backlog business. And what we're seeing because things were so depleted, you have customers that are sitting out there not only getting orders for production but also trying to replenish, and there's pain points in the world. So there are certain product sets that we have some constraints on. There's pain points on some of our input materials, and Heath talked about some of the pressure on the inflation side.

So I think what you have is the orders are a lot higher than our guidance, and our guidance is really the things that we see we're going to schedule out and deliver. And it will normalize over time that there'll be more in check, but right now, you have a supply chain replenishment going on after COVID in 2020 took a lot of supply chains to a full stop.

Your next question comes from Joseph Spak from RBC Capital Markets.

If we look at the actual incrementals in the quarter and compare that to sort of that low 30s, that delta is about $50 million. So is that order of magnitude, what you sort of experienced from logistical headwinds? And then I know you mentioned that could continue. So maybe you could talk about some of the puts and takes on the margin as we head into your fiscal third quarter.

Sure. Joseph, this is Heath. I'll take the question. You're right on with your assumption. We would have expected these volume levels to be north of 30% flow-through, as we've talked about. And so the delta from where -- on a year-over-year basis to where we came in probably puts you into that type of number, in terms of the flow-through and then the impact that it had on margins.

As we work our way through the year, there's certain things that will continue, that we will continue to expect to feel the pressure on, whether that's freight charges, freight inflation or inflation on input materials, otherwise, what the team is hammering through those. We have different levers that we can pull pass some of those things along as well as where we deal with the timing issues on some of that. But I would expect our margins to modestly improve as we work our way forward here into the third and fourth quarter based on some of the actions that are underway and our ability to combat some of the inflationary pressures out there.

Your next question comes from Chris Snyder from UBS.

My question is on EV wins and the pipeline of demand coming to market. Just given the increased focus on high voltage, are you seeing better share relative to ICE? And for these new awards, should we expect initial unit production will carry a CPV above 120 until scale is reached?

Yes. No, thanks. So a couple of things. Let's remember that our share is very -- a leading position in what we do already. So I wouldn't say share is higher. I would say it's in line with our leading share across automotive and transportation.

What is nice, and you talked about it, is where do you see the momentum around EV. And just if we went back a few years, it was 5 million electric vehicles if you take through electric and hybrid. This year, we think it's going to be closer to 10 million vehicles. And you see Europe continuing with the emission programs there. Certainly, Asia has always been strong in there, and these are both regions that we have very strong presence.

So when we think about content, what's nice is EV, you continue to see the adoption. You see the new models coming out. The models are much more attractive, and the consumer acceptance of those is strong. And it pulls in line with our overall content growth in the CPV. We do expect to be that 2x on those high voltages because of what happens with the powertrain.

So it is one of the things that, with an improving recovery, the secular trends of where we position TE, whether it's the electric vehicle in the car, and as I talked about in my script was we also are seeing innovation along the heavy truck fleet. That is becoming more platform-driven. They are going to have more model launches probably out in the 25, 26, and that's going to be a content driver, and we have wins on those. So those secular trends and the backdrop of improving economy just creates more growth opportunity for us.

The next question comes from Samik Chatterjee from JPMorgan.

I wanted to ask on automotive as well. You had strong results in automotive despite the uncertainty we're seeing there with the symptoms of the shortages. Just wanted to ask, Terrence, what are you hearing from your automotive OEMs in terms of how they want to manage the supply chain? Are they still [looking] to model? Or are they ordering ahead? And when do you start to expect some of these shortages in terms of impact on production to start to moderate?

Well, I think when every OEM, number one, is happy with where the consumer is showing up. And if we were here 6 months from now, while we were ramping, one of the things we talked about is the consumer showing. And I think that is great for the industry. And our OEMs are trying to work through the supply chain pressures at a bigger extent than even we're dealing with.

So what was nice, certainly, semiconductors are the big news out there. That is very well documented. Now that impacted production a little bit less than 1 million units in quarter 2. I think it's going to be a similar number in quarter 3, but global auto production, same in that 19 million to 20 million unit range. And what's nice is probably this year all the production will be back to 2019 levels, and that's a little bit quicker than we would have said 6 months ago.

So the OEMs are very much working hard to get the cars out to the consumers. We're all working very much together knowing that right now as it's ramping back up to a very high level. And we're all trying to make sure how do we keep the OEMs going. And so the discussions today are very much around how do we work together to make sure our OEM customers get to capitalize on this opportunity. And there is a lot of volatility right now due to the supply chain. And I think we're going to have to continue to work through that through the rest of our fiscal year.

Next question comes from Mark Delaney from Goldman Sachs.

Yes. Heath, you reiterated the view that free cash flow conversion for this year could be approximately 100% of net income. Can you talk about whether or not there's anything unusual benefiting free cash flow conversion this year? And I recognize there's going to be some puts and takes in any given year going forward. But is that the right type of approximate level to be expecting on free cash flow conversion going forward?

Mark, thanks for the question. I think we've -- one of the things that as I look at the free cash flow and the components and levers we get to pull there, as we've worked our way through the last few years, one of the things you have seen is CapEx as a percentage of sales moderate a bit more closer to that 5% number versus higher than we were running a couple of 3 years ago. That capacity that we have put in place is certainly -- we are benefiting from that now. And particularly as we move forward, I think that number of 5%, maybe 10%, under that this year, is helpful in terms of how that converts cash flow.

The other thing that we obviously benefit from is the way we manage our tax structure and our ability to pay our cash tax rate being much lower than well below our ETR. And so there's a few of those types of things.

But working capital this year has been a good story for us. And our ability to maintain receivable days and payable days, improving year-on-year despite this volatile environment has been good. So nothing unusual in our FY '21 numbers or outlook from a cash flow perspective. I continue to -- we continue to monitor it, and we're not starving the businesses for investments. The organic revenue growth gets first priority, as you can imagine. So we feel good about how we position that. And going forward now, if there's a year coming forward that we have a more significant step-up in terms of an investment or restructuring or something, we'll highlight that. But I think we're in a good position right now.

The next question comes from Joe Giordano from Cowen.

So (inaudible) a little bit of that here. Just if I look back in auto last year in 2Q, I think you had some [40] basis points of benefit from supply chain replenishment then. So if I look at the results from this quarter, and I assume that you grew kind of like in your 600 basis points of -- like is that how I should think about this, that supply chain this quarter was like 900 basis points and it should still be like a pretty favorable number for the next few quarters?

I think it's very difficult to just look at content in 1 quarter, Joe. And you're right, with last year in this quarter, we did have supply chain benefit because we saw people sort of getting into -- as COVID was rolling in, we were trying to secure supply. You need to look at it over longer term. And I think that's the more appropriate way to look at it.

As we said on last quarter, and when we sort of look at mix of vehicles this year, we sort of view -- we should be in the mid-70s without supply chain effects this year. And that's something that is, if you look at what's driven that versus the lower to mid-60s a few years ago, half of that is due to our positioning around electric vehicle and certainly data as autonomy infrastructure gets put in the car. And then the other half is just electronification as our core product set continues to be sourced in as the car gets more features on it.

So I still think this year, without supply chain, we are in that same figure we told you last quarter. I think when you get into where supply chains are trying to move it, it is difficult to get it into one number in a quarter.

Next question comes from Scott Davis from Melius Research.

How do you handle -- how are the contracts handled when you have kind of these excess orders or the double ordering or folks that are more -- I mean, can you get additional price and help offset some of the cost issues and such?

Sure. So on pricing, Scott, when you think about distribution, is about 20% of our business, we did price increases. We do them every 6 months. We did some in January. We have other ones rolling out in July for some of the inflation pressures. What we do have with some of our larger customers, metal writers that have adjusters for metal. So as Heath talked about, we do expect modest margin expansion as we go into the third quarter, some of it is as those things kick in as we continue to try to manage through it. So it is very different by the markets we play in, but there will be price increases aligned with how we have the mechanisms with our customers.

Your next question comes from Christopher Glynn from Oppenheimer.

A higher-level question on industrial automation cycle, how you see that shaping up. The comparisons and the macro are helping you, but during COVID, a lot of people learned to do more with personnel disruptions, and robotics has been a pretty emerging category. I'm wondering if you're seeing the makings of an automation super cycle in terms of investment over the next handful of years.

What I would tell you is if you went back certainly last year, that space got hit. And the year before that, it wasn't a positive cycle. There were elements around auto production going down that were impacting us. So what we see and what -- we see it pretty consistently globally, you're going to have many semiconductor manufacturing equipment. That's accelerating. You're seeing the investments around the auto supply chain. You're seeing a lot of those are in the electric vehicle, at the battery side of it. Certainly warehousing is no surprise either.

So what we have seen pretty consistently globally is an acceleration that, last quarter, we told you we saw some emerging signs of hope, we really saw an acceleration quarter in it. And I do think just with the backdrop we're in, I do think you're going to have a positive cycle here around automation investment as people see an economic recovery that continues.

And let's face it, the 2 markets where we haven't seen it are in comm air and medical, which are both impacted by COVID, where we play in medical. So I do think you can have a stronger like year of an industrial capital equipment cycle that's stronger coming out of COVID.

And your next question comes from David Kelley from Jefferies.

A quick follow-up question on the prior distribution channel exposure. Just hoping you could maybe give us the percent of the order trends there. And if you don't mind, can you remind us of your distribution mix within communications and industrials as well?

Sure. When you take our distribution mix, it is about 20% of the total company. But what you do have, that mix is higher in Our Industrial segment as well as our CS segment. In those cases, you're at 40% plus. In automotive, there's not a lot of distribution. That's a direct just in time, you don't have that.

So you do have higher weightings in communications and industrial. And our revenue growth was in line with the total company revenue growth, sort of mid-teens. But we did see our book-to-bill in that area was higher than total company. It was more like a 150 book-to-bill. And their inventory levels are up. And it's not surprising with -- as the world accelerated, people are trying to secure inventory. They're also trying to rebuild their inventory levels to more appropriate terms. So the book-to-bill was very strong there. And I just think it's another positive sign of an improving economy and certainly as we look forward.

Your next question comes from Jim Suva from Citigroup.

And Terrence, in your prepared comments, you made a comment about the orders being stronger than your lead times. When there's chip shortages and the lead times are stretching out, you normally see that a lot. So can you just help us kind of bridge why would customers be ordering a lot more beyond your lead times? Is it just inventory replenishment? Or do you think that they're fearful of more supply chain issues? Because if your lead times are normal, it seems like they could just put in normal orders versus stretched lead times.

Yes, Jim, a couple of things. So that's realized in automotive, it's a just-in-time system. There really isn't lead times. So in that part of our business, it is just in time. In the rest of our business, our lead time is 4 to 6 weeks on typical. We do have some pain points. And I would probably say in some areas, we're a little bit further out than that but not anywhere close to some of the semis.

I think you do have replenishment going on. People did take volumes down low, and the economy is doing better. In addition, if people see semis and some other passives having shortages, it isn't surprising that people are saying, "Hey, I want to make sure I get my orders on to make sure I don't get surprised in other components and Tier 2 products."

So I think that's why you see what's happening with distribution. I think it's also -- in some of those markets that are very hot that you see that happening. And honestly, our lead times are moving out significantly, except in very highlight product sets, we have some pain points.

Your next question comes from Luke Junk from Baird.

Terrence, I was hoping you could discuss some of the key opportunities in your Energy business as it relates to the proliferation of electric vehicles. It is an area that we're getting questions on. If you could just speak to the role that TE has to play in terms of grid hardening, which, of course, isn't focused on the Texas storms this winter, renewables, you mentioned solar in your comments, and similar.

Yes. So on our energy business and our industrial segment, it is important where we play in that is really along the grid, and it is very much around the electrical infrastructure and it is very global. And the key factors that really drive growth there is hardening, as you said. But also where we pivoted our portfolio and our team has done a nice job has been how do we get our share when you deal with wind applications, where you have high -- very high-voltage connections that need to come back and hook into the grid as well as the solar applications, which are not in panel connections but really taking the energy that comes off the solar grid into the core grid.

And what's nice is the growth that we've seen in our Energy business, that has been pretty consistent over the past year, is really due to our repositioning around renewables. Historically, this would have been a very slow growth business. We have seen it. You saw the 4% this quarter. And that exposure to those renewables is really driving the growth there. And certainly, how EVs drive into energy usage would also benefit that. So we are benefiting all the carbon-neutral initiatives on the planet and certainly how do we make sure we get our fair share with our pretty broad product set to make sure those connections in those grids occur is what we get excited about.

Next question comes from Nik Todorov from Longbow Research.

Terrence, we've seen some reports that some auto OEMs are doing much better than others in the current environment because they have shifted away from just-in-time over the years. As we deal with broader supply chain issues, and I know that's more on the semi side, but how do you see customer inventory policy on the auto side changing? Do you see any structural shift away from just-in-time?

What I would tell you is with what we're dealing with currently, yes, we're trying to meet demand. We have not seen significant shifts. Do the OEMs reflect after this? It will be interesting. I think that will be a discussion we have with our customers. But right now, our customers really focused on making sure they get product out the door. And, in some cases, just realize we don't have some of the production lead time that a semiconductor company would have from when they think about their fabs.

So what we do is different. But certainly, there's stress and strain in the system. And some of the Tier 1s that are also in that equation play a pretty big role, not just the OEMs. And they took inventory levels down very low, and that's what we're all trying to catch up on.

And your next question comes from William Stein from Truist Securities.

Terrence, I think it was you who used the word inflation to describe something that's happening to at least part of your costs. Maybe it was Heath, but whomever takes this is fine. I'd like you to maybe tell us about whether that's something that you're seeing in input costs, material costs, for example, or labor or if it's just supply chain-related costs. And I think you also noted that you'd expect this to be clawed back over time. Is that through essentially a, let's say, deflation in those costs? Or is it something you think you're going to be able to pass on to customers?

William, this is Heath. I'll take the question. Certainly, where we're feeling the biggest inflation right now is on the freight side. The freight inflation has been significant as we battle through there, and there's a variety of reasons for that, including higher air freight and so forth in terms of that, and that's not unique to TE. Certainly, I think that's been as well publicized across the overall supply chain.

We are -- as we move towards the second half of our year, we are seeing a little bit of higher input costs, particularly with resins, and some of that's pretty directly attributable to the weather issues that were in Texas here earlier this past quarter. And then copper prices, as we've continue to monitor those, we've seen those creep up. Now in some cases, we have hedges in place, in terms of how we hedge our metals cost. So you don't see -- you see that kind of layer in a little bit slower in and out of the P&L as we hedge about 50% of our exposure out about 18 months for metals.

So as we get through there, labor cost is not a major issue on the inflation side, but labor availability in certain places that are still being more impacted by COVID continues to drive some inefficiencies, and there's no doubt whether that's in Mexico or in Central Europe. And otherwise, we still are battling through where -- COVID where we have significant operations and that's more around availability than inflation.

In terms of the callback, I think Terrence outlined it a couple of questions ago. In some cases, we have contractual ability to do that in terms of passing through riders as we've seen inflation come in more aggressively. In some cases, it's a broader pricing discussion with a customer and then within channel. Certainly, we'll utilize our ability to take prices up tied with inflation for that piece of the business. And then depending upon the business, there's surcharges and different types of mechanisms that are put in place. But I'd say the timing issue is a portion of it. There's no way I'm going to sit here and say we're going to call back 100% of what we're pounding through right now. But we also put productivity initiatives in place to help offset some of these things. So more to come.

Next question comes from Matt Sheerin from Stifel.

My question is around the Industrial Solutions area, particularly how we should be thinking about operating margin going forward. You were down year-over-year for reasons you talked about, particularly weakness in the aerospace area. It sounds like that's bottoming. It sounds like you're continuing to see growth in the broader industrial market. So what should we be thinking about margin expansion from here? I know you've been targeting high teens. And is it a function of volumes here? Or is there still some restructuring benefits that we should be expecting?

Matt, this is Heath. I'll take the question, and thank you. First of all, nothing has changed in terms of our outlook as that we've been on a multiyear journey to get the footprint right in the industrial segment. And that involves a reduction of -- and consolidation of a lot of rooftops. Nothing has changed there in terms of our multiyear plan to get to mid- to high teens operating margin.

Certainly, within the quarter, we were impacted by a very -- by the mix of businesses where the growth or lack of growth is coming from. Commercial aerospace is a very profitable piece of the segment. And as that's down year-over-year, that has a pinch point in terms of the margins.

However, there's other things that factor into this as well in terms of how we think about the restructuring that's going on, in some cases, when we're -- we do have costs ahead of some of the savings as we're moving factories into new locations. In addition, the segment was not immune from some of the supply chain challenges. So a variety of things, but I am confident as we move into the second half of our year that we will see improvement there, though.

The next question is from Steven Fox from Fox Advisors.

I might have misinterpreted this, but it sounded like you mentioned market share gains more than normal. I was just curious if there's any common thread across while you're gaining share or if there's anything you would point to within the different segments that are driving share gains.

No. What I would say, Steve, I don't -- I think one of the things that's important is we did want to highlight those areas where we do feel there's share gain, not just market improvement. And there are areas that I think we've differentiated during COVID where they created some opportunities. And I think you see that in both units, in the CS segment, certainly, in regard to our industrial transportation business and how we continue to gain share there.

So there are some of the bigger highlights, but we do want to make sure in those areas not only margin recovery, we also had -- took advantage of market share in some key markets that are also contributing to our results.

The next question comes from Rod Lache from Wolfe Research.

This is Shreyas Patil on for Rod. You talked about the -- you mentioned the content opportunity that you're seeing in battery electric vehicles versus ICE. It's about a 2x opportunity. And I think in the past, you've talked about $60 of content on an ICE vehicle increasing to 120 on BEVs. But with certain programs, it seems like you're actually -- the actual content on those vehicles is much higher. So I'm trying to get a sense of, amongst the programs that you're winning, how do you think about this -- the content on those vehicles? How should we be thinking about that? And what's the opportunity there going forward?

Now, when the vehicles are winning, one of the things that you have along as the architecture continues to get scaled and aligned, there is a broader breadth of content per vehicle on electric vehicles for us and you sort of have on traditional ICE and that we get excited about that. And there are some the electric vehicles, it's the traditional 2x and there's some that are much higher, where our customers have asked us to do more.

So there is a broader breadth than you have on a traditional ICE, whereas traditional ICE, it really comes down the feature set. But what's nice is the number of BEVs that you see are accelerating. And when -- at TE, what we get really excited about is as this continues to need to scale to make sure these vehicles are affordable for all consumers, not just on the higher end, that's where we continue to provide scale. And we've always said that as we think through price as it scales, some of these very high CPV elements we talked about will come down a little bit because they have to for the affordability of the cars. And that's assumed in all our content assumptions.

So feel very good about the adoption that it is as global as it is. I think it really stood the test of COVID, but also is when you look at how the architecture in the car needs to continue to scale. That's what we get excited about because automotive is still a scale business. And I think we've proved that with our leading position and what we've done in the ICE, what's nice is our ICE products carry over because they're mainly in the electrical architecture that carries over into the EV. So there isn't real cannibalization because the powertrain is not as big from an electrical side, from an ICE. It just goes way up when you get to a BEV or hybrid.

Next question comes from David Williams from Loop Capital.

I wanted to ask maybe on the mix shift from the automotive OEMs. Obviously, they've pivoted to the higher-end, maybe even more luxury vehicles. Do we see that shift mix maybe move back towards the midrange, lower-range vehicles as the semi shortage eases? How do you think that impacts maybe revenue and a margin impact there?

Well, when you look at that, certainly, the OEMs are getting to make the vehicles they want to make and they make money on. And I think that's one of things that are nice about this improving economy. But I would also say many of the OEMS are also -- have changed their platform pretty dramatically about what vehicles and platforms they make.

So certainly, when you have increased options at our [premium] cars, we would get a little bit of benefit in content than our traditional product. And that's what ebbs and flows over time. And I would also make sure we take a global perspective of it.

I know that very much in the U.S., there's a view of pickup trucks, and that has more content. But when you think about TE, you need to really think globally. And some of those trends aren't as real elsewhere in the world as they may be in the North American market.

Your next question comes from Wamsi Mohan, Bank of America.

Terrence, I was wondering if you could comment, I know it's still early days, but if you could comment on any puts and takes associated with the infrastructure plan, particularly given the amount of investment in EV infrastructure, how that might be a tailwind for TE versus any potential tax headwinds from the proposed tax hikes.

Well, on both sides of those equations, obviously, there's a lot of things out there. So sizing that today is very difficult knowing that there's a lot of things being thrown around. So let's just keep that as an overlay. But I think if you think about any infrastructure, how could that benefit TE, I think, is important. And certainly, I answered a question earlier about energy infrastructure.

Certainly, there's investments that have to happen there that would benefit our Energy business. So if you get infrastructure put in for battery electric capacity in North America versus relying on other parts of the world, certainly, our factory automation team would do it. And any other infrastructure, I think that the other benefit should be -- and we've been very clear on it, we always view acceleration of electric vehicles in Asia and Europe are going to happen quicker than the United States because there has not been as much government support around getting those vehicles adopted. So that could also benefit our auto business.

So there's just some of the bigger elements. And then you would get in your traditional infrastructure where you would have our very strong position in commercial transportation, depending upon what happens with roads and if that creates a machinery cycle, we would participate very well on increases around and certainly, the heavy equipment side due to our industrial transportation. There's some positives that could occur. Certainly, we have to see the bills and the plan shake out. I'll let Heath handle packs, and I'll hand off to him for that piece of it.

Thanks, Terrence. And, Wamsi, you probably recall on the tax side, again, there's a lot of things that are still to be determined. But as you recall, when the last tax reform lowered the corporate rate, it didn't have a big impact on us given our structure and where we're domiciled and where our profit pools lie.

So early look at any of this proposal kind of indicate it probably wouldn't have that much of an impact on us in the other direction either. So more to come as things get solidified there, but I think it's important to look at not just the impact there but where we pay cash taxes. And so not a huge concern at this point, but stay tuned.

Okay. We have no further questions. I want to thank everyone for joining us on the call this morning. And if you have further questions, please contact Investor Relations at TE.

Thank you, and have a great day.

Ladies and gentlemen, your conference will be made available for replay beginning at 11:30 a.m. Eastern Time today, April 21, 2021, on the Investor Relations portion of TE Connectivity's website.

This will conclude your conference for today. You may now disconnect.