TE Connectivity Ltd. (NYSE:TEL) Q2 2024 Earnings Call Transcript April 24, 2024
TE Connectivity Ltd. beats earnings expectations. Reported EPS is $1.86, expectations were $1.83. TEL isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).
Operator: Everyone, thank you for standing by, and welcome to the TE Connectivity Second Quarter Results Call for Fiscal Year 2024. At this time, all lines are in a listen-only mode. Later, we will conduct a question-and-answer session. [Operator Instructions] As a reminder, today’s call is being recorded. I would now like to turn the conference over to our host, Vice President of Investor Relations, Sujal Shah. Please go ahead.
Sujal Shah: Good morning, and thank you for joining our conference call to discuss TE Connectivity’s second quarter 2024 results and outlook for our third quarter. 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, 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 te.com.
Finally, during the Q&A portion of today’s call, due to the number of participants, we’re asking everyone to limit themselves to one question and you may rejoin the queue if you have a second question. Now let me turn the call over to Terrence for opening comments.
Terrence Curtin: Thank you, Sujal, and we appreciate everyone joining us today. As I like to normally do before I get into the slides, I do want to take a moment to provide some performance highlights along with what we’re seeing versus our call 90 days ago. We continue to be in a dynamic global economic environment. Against this backdrop, the performance of our markets is largely consistent with our expectations, resulting in second quarter sales being in line with our guidance with sequential growth in all three of our segments. In addition, we experienced improved order levels with sequential growth in orders in all of our segments, and I’ll provide you more details on orders later in the call. Our results reflect execution against key items we committed to coming into fiscal 2024.
We highlighted to you our focus on margin performance and the benefits from non-volume related operational levers to drive margin expansion. Our progress on these are evident in our results as we delivered 13% year-over-year adjusted earnings per share growth, which was driven by adjusted operating margin expansion of 250 basis points. Adjusted operating margins were up in each segment versus the prior year, and we expect to continue to deliver strong performance through the remainder of this year. With the improvements that we’ve made, we expect to deliver double-digit earnings growth this fiscal year, driven by a couple of 100 basis points of adjusted operating margin expansion even in the slow growth environment. The high quality of our earnings continues to be reflected in our strong cash generation model.
Through the first half of this year, we delivered record free cash flow of $1.1 billion, which is up over 30% versus the prior year, and we expect to deliver another year of free cash flow conversion above 100%. With the strong cash generation, we deployed over $1.5 billion so far this year with $1.2 billion being returned to shareholders and approximately $350 million being deployed last quarter for the Schaffner acquisition that will be in our Industrial segment. Our cash generation model continues to give us both confidence and opportunities to return capital to shareholders, while continuing to support bolt-on M&A activities. So let me now share what we’re seeing in our market since our call 90 days ago. Our view of the transportation end markets remains unchanged from our prior view, with global auto production still expected to grow slightly this year, while we continue to expect weakness in commercial transportation end markets, both in Europe and in the Americas.
In our Communications segment, we continue to see momentum in high speed cloud and AI applications and are seeing the impacts of the destocking coming to the end in both of our businesses in this segment. Because of these trends, we expect the Communications segment to return to year-over-year growth in our third quarter. In our Industrial Solutions segment, the picture is the same that we’ve been saying for the last 6 months. We see 3 out of our 4 businesses continue to have growth momentum. However, our Industrial Equipment business continues to be impacted by destocking. As we think about the Industrial Equipment business, we are seeing early indications pointing to a potential normalization later this fiscal year. And then one other thing I’d like to highlight is that we have seen the dollar strengthen against other currencies since our last earnings call, and this is resulting in an increased headwind to growth and earnings in our second quarter, and this will impact the third quarter as well.
And lastly, I want to reiterate that our long-term value creation model remains unchanged and is centered around 3 pillars. First, our portfolio is strategically positioned around secular growth trends, including the adoption of renewable energy, applications for cloud and artificial intelligence and growth in global hybrid and electric vehicle production. And when you think about the vehicle, we not only benefit from the electrification of the powertrain, but we also benefit from the electronification trends that include increased software defined vehicle as well as increased safety and comfort features. The second pillar of value creation is that we have operational leverage to drive strong margin performance through an economic cycle. And our third lever is that we’ve established a strong cash generation model to return capital to shareholders while investing in bolt-on M&A opportunities.
Now with that as an overview, let’s get into the presentation. I’d ask you to turn to Slide 3, and I’ll discuss some of the highlights for the second quarter as well as our outlook for the third quarter, and then I’ll hand it off to Heath, who’ll get into more details in his section. Our second quarter sales were $3.97 billion which was in line with our guidance and up 3% organically on a sequential basis, with each segment delivering sales in line with our expectations. Adjusted earnings per share was ahead of our guidance at $1.86 which was up 13% versus the prior year. Adjusted operating margins were 18.5%, and this was up 250 basis points year-over-year driven by strong operational performance. We are expecting third quarter sales of approximately $4 billion reflecting organic growth on both the sequential and year-over-year basis.
The year-over-year growth driven by Transportation and Communications segments, partially offset by the effect of a stronger dollar. Adjusted earnings per share is expected to be approximately $1.85 and this is up 5% year-over-year, and it does include a $0.15 headwind from both tax and currency exchange rates. And just moving away from the financials for one second, we did just issue our Connecting Our World report, which details our commitments around corporate responsibility. There are a number of initiatives that we’re driving internally, and our goals are in line with both our purpose as well as our expectations from our customers. Some of the key highlights that I want to bring up to you is that we did achieve a 70% plus reduction in both Scope 1 and Scope 2 greenhouse gas emissions over the past 3 years and we also set our Scope 3 reduction targets and these have been validated by the Science Based Target initiatives.
So with that as a quick overview of the quarter and our outlook, let me get into more details on orders and that starts on Slide 4. As I highlighted earlier, we are seeing improved order levels. Our orders were up 6% sequentially to $4 billion with sequential growth in each segment. And really, this is the first time in a year and a half that orders have been above $4 billion and our book-to-bill is above 1. And we do believe that order patterns are indicating stability in most of our end markets we serve as well as the consistent service levels that we’re providing to our customers. Now, getting into orders by segment. Transportation orders grew sequentially despite auto production declining sequentially to a little bit below 21 million units in the second quarter.
We saw production in China that offset incremental weakness in North America. And going forward, we expect global auto production to be roughly 21 million units per quarter as we move through the second half of this fiscal year. In our Industrial segment, we saw 7% growth in orders sequentially, and this reflects the continued momentum that is offsetting ongoing destocking in the industrial equipment end markets. And in our Communications segment, our orders grew 30% sequentially, reflecting design win momentum in data center programs, and about half of the increase was driven by AI orders for delivery in 2025 in our data device businesses. Now with that as an overview of orders, let me now discuss year-over-year segment results, and I’d ask you to turn to Slide 5, and I’ll start with Transportation.
In Transportation, our auto business grew 1% organically with double-digit growth in China offset by declines in North America and Europe. While global auto production levels are consistent with our prior view, we are seeing different dynamics by region. Versus 90 days ago, our expectations of vehicle production have increased in China with a continued strong outlook for EV adoption and expansion in our content per vehicle. In North America and Europe, OEMs are adapting their mix of production to better align with consumer preferences. Factoring in these dynamics on a global basis, EV and hybrid production are both expected to increase by 24% this fiscal year, and we’ll continue to see declines in internal combustion engine production. The increase in the electrified powertrain autos will be driven by increased production in Asia, which is our largest sales region and where our auto team has a strong position.
And just to give you a reminder, our content per vehicle is 1.5x higher on a hybrid, and 2x higher on a full electric EV versus internal combustion platforms. We have established a global leadership position across all vehicle platforms at all major OEMs and start ups and continue to expect long-term content growth above production of 4 to 6 points. Now turning to the commercial transportation business. We saw a 4% organic decline, and this was driven by the heavy truck market declines in North America as well as in Europe. This was partially offset by a return to growth in China. And we expect this business to be down sequentially in the third quarter and expect these markets that we serve here to be down approximately mid-single digits this year due to market declines in the West.
In our Sensors business, the sales decline continued to be driven by market weakness in industrial applications as well as portfolio optimization that we’ve talked to you about, where we’ve continued to organically exit lower margin and lower growth products. For the Transportation segment, adjusted operating margins were 20.4%, which is slightly above our target levels, and we expect to run on our target margins for the rest of this year. We are continuing to invest in our increase our investment in our auto business to support engineering requirements for next generation vehicles and whether they’re around the electrification of the powertrain, high speed Ethernet for data applications in the vehicle or miniaturized power and signal products to leverage next generation architectural shifts.
Now let’s get into the Industrial Solutions segment, and that’s on Slide 6. In this segment, we continue to see the trends that we’ve discussed for the past few quarters. And while sales were down 6% organically at the segment level in the second quarter, we saw growth in 3 of our 4 businesses, and we expect continued growth in our AD&M, Medical and Energy businesses. In the second quarter, our AD&M sales were up 17% organically, driven by growth in both the commercial aerospace and defense market. In medical sales in the quarter were up 6% organically, driven by ongoing increases in interventional procedures. And in Energy, we saw organic growth driven in the Americas, offset by weakness in Europe with continued strong momentum in renewable applications.
And then finally, in our Industrial Equipment business, where we’re continuing to see the destocking, our sales were down 28% organically. While we’re seeing some stabilization in order patterns pointing to normalization later this year, we still expect to see year-over-year declines in this business for the next couples of quarters as our customers are just inventory levels. On a margin perspective, the Industrial segment achieved 15%, which was in line with our expectations given current volume levels and business mix. We continue to expect segment margins to run into the mid-teens until the Industrial Equipment business returns to growth. Now I’d ask you to turn to Slide 7, and let me get into the Communications segment. In Communications, I am excited about a return to year-over-year growth in our third quarter now that destocking trends are largely behind us and momentum continues to build in next gen cloud applications.
Going forward, we now expect to deliver higher growth from artificial intelligence applications where we’re increasing our investment to support future growth opportunities. Based upon our design win momentum, we expect to double our AI revenues from $200 million this year to $400 million next year and expect to build on this momentum to achieve annual revenues of roughly $1 billion in the following few years. Just a reminder where we play, we are focused on providing high speed, low latency connectivity to meet the needs of artificial intelligence workloads. And we generate 50% more content in accelerated compute platform versus traditional compute servers. Also, we’re working closely with cloud customers as well as leading semiconductor companies with reference designs that call out TE Connectivity solutions.
This segment had adjusted operating margins of 17.3%, and this was up 100 basis points over last year despite the decline in sales in the second quarter. Our teams are executing extremely well, and we continue to expect to maintain high-teens margin in this segment as we move through the year while supporting investments for growth. As volumes increase over time, we expect to achieve our long-term margin target for the segment of approximately 20%. Now with that as a segment overview, let me hand it over Heath, who’ll get into more details on the financials and our expectations going forward.
Heath Mitts : Thank you, Terrence, and good morning, everyone. Please turn to Slide 8, where I will provide more details on the second quarter financials. Adjusted operating income was $735 million with an adjusted operating margin of 18.5%. GAAP operating income was $692 million and included $3 million of acquisition related charges and $40 million of restructuring and other charges. For the full year, our expectations are unchanged and we continue to expect fiscal 2024 restructuring charges to be approximately $100 million. Adjusted EPS was $1.86 and GAAP EPS was $1.75 and included restructuring acquisition and other charges of $0.11. The adjusted effective tax rate was 21% in Q2, and for the third quarter and the remainder of the year, we expect our adjusted effective tax rate to be approximately 22%.
Importantly, as always, we continue to expect our cash tax rate to stay well below our adjusted ETR for the full year. Now if you turn to Slide 9, sales of $3.97 billion were down 5% on a reported basis and down 3% on an organic basis year-over-year, which is as expected. Sequentially, we saw 3% organic growth in sales. Adjusted operating margins were 18.5% in the second quarter, expanding 250 basis points year-over-year, and this was driven by margin expansion in all three segments on a year-over-year basis. We have been focused on executing on a number of operational levers this year that are not volume related and this has enabled strong margin expansion despite the low growth environment that we are dealing with. Adjusted earnings per share were $1.86 up 13% year-over-year driven by the strong margin expansion.
Turning to cash flow, cash from operations was $710 million and free cash flow was $543 million in the second quarter. Through the first half of our fiscal year, free cash flow was $1.1 billion which is up 32% year-over-year. Our long-term capital strategy remains unchanged, which is to return approximately two thirds of free cash flow to shareholders and use one third for bolt on acquisitions over time. As mentioned earlier, we expect our free cash flow conversion to exceed 100% again this year. Now before I turn it over to questions, let me reinforce some of the key points that we are excited about and share how we are thinking about our performance in the current macro environment. We are delivering margin expansion, EPS growth, driven by strong execution on operational levers.
At the same time, we are investing to support future growth in markets with strong secular drivers, including next generation automotive, renewables and the artificial intelligence applications that Terrence just discussed. We are seeing an improvement in order patterns and sequential orders growth in all of our segments indicating stability in most of the markets we serve and giving us confidence in future growth. Our communications segment is returning to growth in the third quarter, which reflects both the normalization of supply chains as well as our momentum in high speed data center applications. And finally, we are demonstrating our strong cash generation model with a balanced deployment of capital. So we remain very excited about the opportunities we have ahead of us to drive value creation for all stakeholders.
With that, let’s now open this call up to questions. Dennis, can you please give the instructions for the Q&A session?
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