TE Connectivity Ltd. (TEL) Q2 2012 Earnings Report, Transcript and Summary

Ladies and gentlemen, good morning. Thank you for standing by, and welcome to the TE Connectivity Second Quarter Earnings Release. [Operator Instructions] And as a reminder, today's conference is being recorded. I would now like to turn the conference over to our host, Vice President, Investor Relations, Mr. Keith Kolstrom. Please go ahead.

Good morning, and thank you for joining our conference call to discuss TE Connectivity's second quarter 2012 results. With me today are Chief Executive Officer, Tom Lynch; and Chief Financial Officer, Terrence Curtin. During the course of 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 at te.com. On April 10, 2012, we announced the planned divestitures of our Touch Solutions and Professional Services businesses which we expect to close in the fiscal third quarter. Results for these businesses are now being reported as discontinued operations for the current and prior periods. Second quarter impact versus our January guidance was a reduction in sales of about $150 million and a reduction in adjusted EPS of $0.02. Please refer to the 8-K filed on April 12, 2012 for the recast of prior period financial information. [Operator Instructions] Now let me turn the call over to Tom for some opening comments.

Thanks, Keith, and good morning, everyone. If you could now please turn to Slide 3. Q2 was a solid quarter for the company. Sales of $3.25 billion were at the high end of our guidance range. Adjusted EPS of $0.68 were above the high end of guidance due to another strong quarter of performance in our Transportation segment. Free cash flow is very strong at $379 million, and our operating margin improved 90 basis points sequentially to 13%, a sequential improvement in all of our segments. From a strategic perspective, we continued to strengthen our portfolio with the closing of the Deutsch acquisition in early April and the planned divestiture of Touch and Services. Orders strengthened during the quarter, and book-to-bill excluding our SubCom business was 1.03, up from 0.98 in Q1. Market trends in our Transportation segment continue to be strong, particularly in Automotive and commercial Aerospace. Telecom, DataComm and appliance markets started to show some strength in the quarter, coming off a relatively weak Q1. Industrial Equipment markets were up slightly in the quarter, however, the improvement is coming a little slower than we expected. Our Consumer business was down slightly as expected. Overall, orders are picking up. But there is still a fair amount of uncertainty in the global economy. On a regional basis, we see strengths in most U.S. markets. And in Europe and Asia the markets remain mixed, with the exception of Automotive. The company's operating margin was back at 13%, as all of our businesses improved margins in the quarter. And importantly, CIS profitability improved sequentially by about 150 basis points on essentially flat revenue. We do expect CIS margins to be back to the double-digit operating level in the second half. Our outlook for the full year is for sales of $13.5 billion to $13.8 billion; adjusted EPS of $2.88 to $2.98 per share; and free cash flow of approximately $1.3 billion. Compared to our view of a quarter ago, the Automotive market is a bit stronger. Industrial markets are improving, but not as much as we had thought. And revenues in the SubCom business are down due to customer funding delays. The net effect is that our full year guidance is down by approximately $100 million in revenue and $0.03 in earnings per share. We do expect -- we continue to expect to have a strong ramp in the second half, with revenues up 13% and EPS increasing 24%. We also expect our adjusted operating margins to improve to the 14% level in the second half. Now please turn to Slide 4. We're very excited to have Deutsch join TE. They provide a broad range of harsh environment connectivity solutions, and fill an important gap that exists in our product portfolio. As we've indicated before, we expect to grow revenue of Deutsch products at the 8% to 10% per year range and improve the EBITDA of the business from current levels of about 26% to approximately 30% in year 3. We're going to do this by leveraging our scale and our supply chain, integrating our go-to-market organizations and leveraging our strong position in emerging markets. For the remainder of 2012, we expect Deutsch to contribute approximately $370 million in sales and $0.08 of EPS, consistent with what we've indicated earlier. This is about 9% revenue growth versus last year for that business. Our expectation for fiscal 2013 for Deutsch remains the same as previously communicated, approximately $760 million of sales and $0.20 of EPS. Now I'm going to turn over to Terrence to take you through the quarter in more detail.

Thanks, Tom, and good morning, everyone. I just want to highlight, as Keith mentioned, that all the numbers I'll review today as I go through the financials reflect the treatment of our Touch and Professional Service businesses as discontinued operations. If you could please turn to Slide 5 and let me get started with our sales performance. Total company sales were $3.25 billion, which was at the high end of our guidance and they were down 3% year-over-year on an actual basis and down 1% on an organic basis. The difference between the actual and organic growth was driven by the effects of a stronger dollar compared to last year. We continued to see strong growth in our Transportation segment, which grew 7% versus last year, while our CIS segment was down 12% and our Network Solutions segment declined 6% due to slowness in certain end markets, as well as the impact of inventory adjustments by our customers. On a sequential basis, our sales grew 3% on an actual basis and 4% organically. The sequential growth was in line with our expectations in both the CIS and Network segments, and was better than expected in our Transportation segment. Looking at our revenue by geography and on an organic basis versus last year, our sales were flat in Asia and down 2% in the Americas and Europe. Now let me get into more highlights in key markets in each of our segments. And unless I indicate otherwise, all changes I discuss will be on an organic basis, which excludes the effect of currencies and acquisitions. So please turn to Slide 6. In our Transportation Solutions segment, we had another strong quarter. Sales increased 7% on an actual basis versus the prior year and 9% organically. In the Automotive market, our sales increased 9% versus the prior year and sales were up 13% in Asia, 12% in the Americas, as well as 4% in Europe. Global vehicle production was approximately 21 million units in the quarter, and this was up 4% compared to the prior year. Vehicle production trends are positive in both North America and Asia, however, the Europe region remains soft and production was down 5%. We do expect third quarter production to be flat with quarter 2 at about 21 million units, and we expect full year production estimates at around 81 million vehicles, which is a 5% increase versus prior year. This vehicle growth in production is occurring in North America and Asia, offset by a slight decline in Europe on a total year basis. And we expect our full year revenues to grow about 7%. In the Aerospace, Defense & Marine market, our sales were up 13% versus the prior year. This growth was due to strong demand and increased share in both the commercial aerospace and oil and gas markets. For the segment overall in the third quarter, we expect the Transportation revenues to be up 7% on an organic basis compared to the prior year, which does exclude Deutsch. And Deutsch is expected to add an additional $190 million to revenue in the segment in the third quarter. Please turn to Slide 7 so I can discuss our CIS segment. In this segment, total sales declined 12% on both an organic and actual basis versus the prior year. Sequentially, sales were flat as we expected. In the industrial market, sales were down 14% versus the prior year, but did improve sequentially by 3%. And we expect an additional 5% to 7% sequential increase in our third quarter. We are seeing this market start to pick up, but not as much as we previously had anticipated. In the DataComm market, which includes sales to the communication equipment, server, storage and wireless equipment markets, our sales were down 18% versus last year due to reduced broadband and wireless spending. Sales were flat sequentially, and we continue to expect improvement in the second half in this market of our fiscal year. In the Consumer Device area, our revenues were down 8% versus the prior year due to continued softness in the PC, feature phone and consumer electronic markets. And in the appliance business, we were down 6% versus the prior year due to soft demand in Europe and Asia. However, our sales did grow 13% sequentially due to an improved demand picture in the U.S. In quarter 3, we expect our CIS segment revenues to grow sequentially 7% to 10% with improvement in all of the markets. Let's turn to Network Solutions, and if you could please turn to Slide 8. Total sales were down 6% at actual rates and down 4% on an organic basis versus the prior year. We did see an improvement sequentially of about 4%. In the Telecom Networks market, our sales were down 6% versus the prior year, but we saw improvement of 6% sequentially. The year-over-year declines were in line with our expectations due to reduced carrier spending in the U.S., but we did see order rates improve in the quarter, and we expect this momentum will continue through the balance of the year. In the Energy market, our sales were up a strong 9% versus the prior year with growth in all regions led by over 20% growth in the Americas, which was due to increased customer investment as well as increased market share. We expect to see normal sequential -- seasonal growth in the second half of the fiscal year as investment in distribution, transmission and power generation continues to increase around the world. In the Enterprise Networks market, our sales were essentially flat, as strength in data center investment was offset by declines in office network spending. And finally in our SubCom business, our sales declined 19% year-over-year. Several projects that we've talked to you about that have been awarded still have not come into force. We currently expect that quarter 3 sales will be similar to quarter 2 levels at $120 million of revenue, which is lower than we anticipated a quarter ago. We do expect to step up in quarter 4 to about $140 million in revenue, as we do expect one of the contracts to come into force later in Q3. We now expect that the SubCom business revenue will be about $520 million in 2012 compared to our prior expectations of $600 million. Overall, we expect in quarter 3 Network Solutions segment sales will be up about 9% sequentially despite softness that we have in SubCom. Let me now discuss earnings. Let's get started on Slide 9. Our GAAP operating income for the quarter was $385 million, which includes $32 million of restructuring and other charges and $4 million of charges related to the acquisition of Deutsch. We continue to expect $75 million of cash charges related to the acquisition of Deutsch. About 1/2 of these cash charges will be incurred in 2012, and the remainder will come primarily in 2013. In addition to these cash acquisition costs, we currently estimate about $55 million of non-cash acquisition charges that will be driven by purchase accounting. The majority of these non-cash charges will occur in our third quarter, with the remainder primarily occurring in the fourth quarter. Turning back to quarter 2 results. Our adjusted operating income was $421 million in the quarter with an adjusted operating margin of 13%. Both growth -- gross and the operating margins were above our original outlook for the second quarter. The 90 basis points of sequential improvement in our adjusted operating margin resulted from the cost actions we initiated over the past 9 months, as well as continued strong performance in our Transportation segment. All segments had sequential operating margin improvement. Also at the revenue levels we expect in the second half of $3.6 billion to $3.7 billion per quarter, we continue to expect the operating margins to improve to about 14%. On an adjusted EPS basis for the quarter, we reported $0.68. This was above the high end of our guidance range due primarily to the higher operating income. Please turn to Slide 10. If you look at the top left of the slide, our adjusted gross margin in the quarter improved 170 basis points sequentially and was back to 2011 levels of approximately 31% due to the cost actions and the operating leverage on the sequential volume growth. We expect that our gross margins will stay approximately 31% in the third quarter. If you look at the bottom half of the slide, operating expenses as a percentage of sales were 18.4%. In quarter 3, we expect that RD&E and SG&A of approximately 5% and 12% of sales respectively, as we leverage our operating expense structure on the higher sales volume. Let me turn and discuss items on the P&L below the operating line. If you could please turn to Slide 11. Net interest expense was $37 million in the quarter, up from $34 million last quarter due to the issuance of debt in advance of the Deutsch acquisition. As we discussed when we announced the Deutsch acquisition, part of the debt raised was a pre-funding of our upcoming bond maturity in October. Because of the pre-funding, our net interest expense will remain slightly elevated at approximately $42 million per quarter in the second half before being reduced in 2013 by about $8 million per quarter once we pay down our October maturity. Other income, which relates to our Tax Sharing Agreement, was $11 million in the quarter. We expect in quarter 3 it will be approximately $9 million. On the effective tax rate on both a GAAP and adjusted basis, the effective tax rate was 25.3% and we expect the adjusted tax rate to be about 26% in quarter 3 and in quarter 4. If you could please turn to Slide 12, let me now discuss free cash flow. Our free cash flow in quarter 2 was $379 million, which was a very strong result. Cash from operations was $481 million, and we continue to expect free cash flow for the full year to approximately net income at $1.3 billion. Capital spending during the quarter was $140 million or about 4% of sales, and for the full year we continue to expect that capital spending will be in the 4% to 5% of sales range, in line with our long-term expectations. Please turn to Slide 13, so I can talk about cash, debt and liquidity. We ended the quarter with $2.9 billion of cash, and we used $2.05 billion of that cash in April to acquire Deutsch. Outstanding debt temporarily increased to $4 billion at the end of the quarter due to the borrowing for the Deutsch acquisition. We expect to reduce this debt level to approximately $3 billion following the payment of our $700 million debt maturity in October. During the quarter, we paid $76 million of dividends. And as we talked on the last call, in March, our shareholders approved the increase we proposed in the dividend to $0.21 per quarter, and this dividend rate will go into effect with the June dividend payment. I also want to highlight, related to the planned divestiture of Touch and Professional Services businesses, that with the generation of the $400 million of proceeds that we expect to get as these deals close in the third quarter, we anticipate restarting our share repurchase program in the fourth quarter. So if you could please turn to Slide 14 and let me briefly discuss order trends. Total company orders in the quarter were $3.2 billion, and the book-to-bill was 1.03 excluding SubCom. Our book-to-bill rate in the Transportation segment was 1.02, where orders continue to be strong due to the steady demand in the Automotive and commercial aerospace markets. In Network Solutions, excluding SubCom, our book-to-bill was 1.08 and was driven both by normal seasonality and the increased spending by the carriers in the second half compared to our first half. In our CIS segment, our book-to-bill was 1.01, which is a big improvement versus the prior quarters, as channel inventories return to more normal levels and we see the improvement that we expected as we ramp in the second half. So let me now turn it back to Tom, who will cover the outlook.

Thanks, Terrence. Please turn to Slide 15. For the third quarter, we expect our sales to be in the range of $3.55 billion to $3.65 billion, up about 11% sequentially, and earnings to be in the $0.77 to $0.81 per share range, up 16% sequentially. And now, if you'll turn to Slide 16 for our full year outlook. We expect sales to be in the range of $13.5 billion to $13.8 billion, and EPS is expected to be in the range of $2.88 to $2.98 per share. Now just to kind of recap here before we go to Q&A and highlight what I think are the key things. In Q2, we did see orders strengthen. That was important to set up the rest of the year. Orders were up 8% over the Q1 level. As we've pointed out, segment operating margins improved across all of our segments. And importantly, CIS is close to that double-digit range again and we did have a strong cash flow quarter. And as we look in the second half, we expect sales to grow 6% to 8% organically compared to the first half at about 12%, including Deutsch. And as I just mentioned, we expect second half EPS of $1.62 compared to $1.31 in the first half. Also we'll be back at the 14% operating margin level, at around the $14 billion revenue level as our operating leverage is kicking back in as the volume picks up. And as Terrence pointed out, with the divestitures of -- the divestiture of the Touch and Services business, it's likely that in late Q3 or Q4, we'll get back into our share repurchase program. And then finally, again, the Deutsch acquisition is a tremendous acquisition for us. It will contribute $0.08 this year and $0.20 next year. Strategically, it gives us a product line we haven't had. And for 2 of our businesses, our Aerospace, Defense and Marine business, that's now going to be a $1 billion-plus business for us. And our Industrial Transportation business, which is part of our Automotive business, is going to be close to $1 billion business. So it really strengthens the portfolio and strengthens our industry position, so we're very happy to have the Deutsch team as part of TE. So with that, I will open up for questions. If you could, Mr. Operator?

[Operator Instructions] And our first question today comes from the line of Shawn Harrison, representing Longbow Research.

Just first question I wanted to delve into, I guess, kind of the auto markets and any disconcerting trends you're seeing there. And then long term, where do you think the EBIT margins of the TS business should be, given the inclusion of Deutsch now?

No real disconcerting trends in the auto market, Shawn. I would say China is clearly -- has been, and we expect for a couple of quarters to be growing much slower than it has since the financial crisis in 2009. It's in the low to mid-single-digit growth rate. We're growing about twice that, but I would -- we don't see any disconcerting trends in orders. This far in April, it continues to be solid. And as Terrence pointed out, auto production is going to continue to run at the 20 million to 21 million level per quarter.

And Shawn, on your second part of your question related to OI margins, our Transportation segment's running at 16% now. When you take in, certainly, the EBITDA that we quoted, Deutsch will be around 27% in our guidance. When you take out the purchase accounting, amortization, depreciation, it gets Deutsch to about 17% right now, OI. That's only about a 10-basis-point improvement in Automotive or our Transportation segment, so it's actually only a slight increase. And on the total company for this year, it's about a 10 to 20-basis-point increase.

And long term, do you think that Deutsch should be closer to a 20% OI, correct?

Correct.

Okay. And then just a follow-up question. Where do you think you are in terms of just completing some of the restructuring and cost reduction actions in the other businesses? Have we kind of seen the full benefits of that or are more of those to come during the back half of the fiscal year?

I'd say, Shawn, the big structural, restructuring is largely behind us. We did have a little bit more related to the CIS business. We've been -- we've reorganized that business over the last 6 months, and it's a leaner structure now. But I would say, Terrence, no big structural. I think we'll always be fine-tuning the business as the trends shift and production shifts to follow-up customers.

Yes. I think, Shawn, when you look at it, certainly this quarter, we had -- you saw the benefit of some of the cost actions we took. As you saw on flat revenue, the margin went up 150 basis points. We still, even though in the industrial market, volume is a little bit lower. As you go through the year, we do -- we still see CIS getting up in the fourth quarter to about the 12% rate, so we still continue to see that benefit coming based upon the cost actions we've taken.

Next question today comes from the line of Amit Daryanani with RBC Capital Markets.

Just have a question on the Transportation side. Specifically on Europe being up 4% organically, do you have a fear or sense that you may be potentially pulling in some production from the back half to the earlier part of the year? Given car registration -- the new car registration in Europe are tracking well below the production number I think so far in calendar Q1. And then any impact coming from the explosion at a resin manufacturing plant in Germany? And if you could talk about if that's encompassing your forward guidance?

No, we don't see any of that related to pull-ins. Remember, a lot of the auto production in Germany is export, and what we're seeing is even though China, for example, is growing only in single digits now, the high-end vehicles are still growing much higher than that. So there is that impact. It's not being driven by local European demand, but you're right. That is down. It's still more export power.

And on the resin question, we don't anticipate any meaningful stop in production in our guidance related to that based upon where we see production levels right now.

Fair enough. And then maybe if you -- if I look at operating margins for the back half at 14%, about 100-basis-points improvement from the Q2 level, could you maybe just walk us through how much of that benefit is from Deutsch coming in versus divestitures versus organic leverage? I think the leverage is probably 50% of that margin expansion. I just want to confirm that.

Most of that is organic leverage or due to the volume flow-through picking up 10% plus.

In your categories, because of the divestitures, between Touch and Services, that really does not benefit or rate that much of our rate. Deutsch, as I said, is 10 to 20 basis points, so when you look at that expansion...

On Transportation...

On -- and overall. And also overall. And when you at really improvement in Network Solutions and CIS based upon the volume leverage and prior cost actions.

Our next question today comes from the line of Wamsi Mohan with BoA Merrill Lynch.

This is Ruplu filling in for Wamsi. First, I just wanted to touch on the guidance for Deutsch. It looks like you're guiding for $0.08 for this fiscal year and $0.20 for next fiscal year, but that seems a little bit conservative because from what I understood, Deutsch has about a 5% to 6% annual growth rate or that's what I remember. So is the $760 million revenue for fiscal '13, is that a conservative estimate? And because you're getting $0.08 for 2 quarters and then you're guiding $0.20 for the full year, so I just wanted to get your -- some clarification on that.

A couple of things. When you look at it, Ruplu, certainly there's seasonality in their business that the first half is typically lighter than the second half. So when we look at things right now, we believe the guidance we gave previously is appropriate and certainly, just taking a second half and annualizing it for the Deutsch business, there'll be a little bit of seasonality in our first and second quarters next year. So it's still in line with what we said when we announced the acquisition.

Okay, great. And just wanted to ask on the -- in CIS, in terms of inventory corrections, do you think at least in the industrial inventory corrections are done with? Or do you expect to some of that to also flow into the third quarter?

I think it's substantially complete, and we're looking for a sequential growth in industrial in the high-single digits. So I think most of it is behind us. And as long as end demand also begins to pick up, we're hearing that -- from our big distributors that their inventory levels are pretty close to where they like them to be.

Our next question comes from the line of Craig Hettenbach with Goldman Sachs.

Just wanted to follow up, Tom, on Deutsch. Some of the pushback, I think, on that deal was on the price side. So if you can just walk through your view of some of the synergies, particularly on the top line side and any feedback? I know it's early on, but whether it's from your sales force, channel partners in terms of the portfolio for Deutsch and implications for growth.

Well, the feedback from our channel partners is extremely positive. And as you know, we've been doing a lot to strengthen our channel business, which was always strong given the size of the company. But in the last 3 years, it's gotten stronger. And this was a product line we didn't have. So through the channel, it's really important the broader the product line, the better. And this is an attractive product line because it's very high end and highly engineered. So we see a fair amount of synergy through the channel. We also see the ability to take this into other markets where we don't have a circular connector product line. That'll take probably a couple of years to do that. And then as I mentioned in my comments, the ability to leverage our supply chain, and I mean we're very, very bullish on the -- both the channel and customer synergies, the emerging market synergies and the opportunity to take our scale, our connector business, being about a $10 billion business, and help out the Deutsch business, which is about a $700 million business.

Yes. And on the cost side, Craig, just to reiterate. In addition to the supply chain, when we look at taking the EBITDA from $26 million to $30 million, 1/2 of that is in the gross margin area. The other half was in the OpEx structure. Some of it relates to synergies in the back office, as well as the go-to market. So when we look at that, that's just getting started and I think we're off to a good start on the integration. So from that viewpoint, early indicators are positive.

Okay. And then if I could, as a follow-up, it looks like a nice snapback for the networks and comm business into the June quarter. Can you talk about what you're hearing from customers there? And any notable trends by geography to highlight?

I think you're just seeing in the DataComm equipment side, it's probably a little more that the inventories are getting back and balanced, so there's not the penalty in the sense that we've been going through having too much inventory in the channel and therefore, the negative adjustment that occurs. And we are seeing some pickup in end demand, but I'd say most of the benefit in the sequential growth is inventory-related in a positive way. And in the telecom, as you know, in the U.S., and to some extent in Europe, the spending in our Q4 and Q1 was down. A lot of it related to everything that was going on with the big carriers and some of those previous issues we're shaking out. But we're seeing that spending to get back. Now spending for the full year in the carrier business is still going to be relatively flat to slightly down. So it was a big year last year. You had a low first half this year, kind of a recovery in the second half. And hopefully, we would expect to get back into a more normal spending next year. But no big discernible trends, I would say. Terrence?

No. I mean, to Tom's point and the Telecom Network space and when you look at North America specifically, we expect our business to be basically flat year-over-year in the second half. So it's certainly improving nicely sequentially as spending starts to pick back up. So from that viewpoint, it's sort of happening as we expected 3 months ago.

Well, NBN does kick in, in the second half for us. So not huge, but it starts to build. Everything's getting lined up for that right now.

Our next question comes from the line of Jim Suva with Citi.

This is Samuel Meehan on behalf of Jim Suva. Now that we've anniversaried the closing of ADC, do you mind giving an update on the acquisition targets? I recognize that ADC contributed $150 million of incremental sales this quarter. But on the cost side, are you hitting the goals of, I think, originally outlined $100 million of cost savings and 1/3 of that should be on the manufacturing restructuring? And then expectations for double-digit operating margins in this segment?

Yes, Samuel. It's Terrence. On that, if you actually look, we basically, right now in this quarter will have, since we acquired them, about $25 million of run rate cost synergies. So when you look at that, we're right on target with what we said publicly. And that's about a $15 million improvement year-over-year. So last year in the second quarter, we had about $9 million in this quarter. So from a cost perspective, the ADC is right on, certainly from a volume, the AT&T items we talked about in North America. Volume was a little bit softer. And as volume comes back, we do believe we'll be right on with the acquisition targets we laid out. So volumes a little bit of pressure, but the cost side's right on.

Okay. And then given ADC and also Deutsch, can you just remind us TEL's M&A strategy going forward?

Sure. I think we've laid out, but happy to relay out. Fundamentally, very strategic-driven, meaning we don't sit and wait for somebody to give us the call. So it's areas that, for several years now, that we wanted to establish leadership position with ADC, gave us a leadership position in the Telecom Networks business, tremendous fiber optic portfolio. With Deutsch, it fills that hole in both Aerospace, Defense and Industrial Transportation and gives us the product line for our broader industrial business to give us the full range. I mean, we had a pretty full range before and this really gives us a great product range. And then as we look forward, we do -- we like the energy infrastructure business. We like the industrial business. They're both pretty fragmented businesses in the sense that they're served by lots of companies like ourselves, and we do have a leading position there. But there's still, I believe, the opportunity over the years. So that's where we focus our efforts right now.

Our next question comes from the line of Amitabh Passi with UBS.

Terrence, perhaps the $130 million volume adjustment you've made to the full year guidance, is the bulk of that coming from your Subsea segment? It sounds like you took that from $600 million to $520 million. I'm wondering if you can just help us understand where you see those volume adjustments coming from, the $130 million that you called out?

Sure. When you -- you are right on that, Amitabh. So when you look at it and take Deutsch out, take the discount, moving pieces out, when you look at it, it's actually auto is a little stronger, as you saw in the second quarter. And then the 2 areas where it's weaker than we guided 3 months ago is SubCom certainly to the projects. We've been winning our fair share of the projects, but some of the funding's been taking a little bit slower. We expected one project that's based in Asia to come into force earlier. We expect that to come into June. Certainly, that project's going to ramp lower than we expected. That's the $80 million. The other piece, as both Tom and I indicated, the industrial markets and our CIS business were ramping nicely. They just were ramping a little bit slower. So that's the other area which was a little bit slower than 3 months ago, but the number you stated, the $130 million, is right on. Really SubCom and industrial are the areas that are a little bit slower.

And then just as my follow-up, can you give us some sense of how we should be thinking about SubCom looking out of fiscal '13? And then maybe any sense of the NBN ramp as we move into fiscal '13?

Sure. Starting with SubCom, when you think about SubCom, we feel that right now, you should probably think about SubCom at $600 million next year. So as these projects come into force, certainly we will always update you. It can be a lumpy business. So if some more projects come into force, it could be higher than that. But right now, let's say you should think about $600 million. In NBN, NBN in our current year, really in our third and fourth quarter, as Tom mentioned, is about $25 million, $30 million of revenue this year. That could ramp, depending upon deployment, up into the $100 million range per annum over the next 10 full years as we talked previously. So we're starting to see in our third quarter some NBN activity as they're mobilizing their deployment and how that goes could go up to about $100 million per annum based upon the ramp. Then that could get up there maybe next year.

Next question comes from the line of Steven Fawkes representing Cross Research.

First question, just going back on Deutsch. I thought I heard that you said it's -- the business has been growing about 9% year-to-date, which I think would be a little bit faster than you would have said back in December. So maybe if you could just dive into what the trends are specifically at Deutsch that you've been able to analyze since you've acquired it? And then secondly on Deutsch, how quickly can you start putting those products into your own distribution channel? What sort of time line have you laid out with your channel partners to expand your product offering there?

Let me take the first part. This is Terrence. When you look at Deutsch, it is, if you take their second half to second half, the $370 million, they're growing about 9%. When you look at -- they are getting a little bit of benefit to some penetration in the oil and gas area that is creating that growth and this compare to be towards the 9% area. In the Aerospace and the Industrial Transportation, it's closer to that 6%. So right now they are getting some favorable momentum with some projects they won in the oil and gas area, which as we discussed previously, was sort of an emerging area. So right now, it is a little bit stronger than we said, really due to oil and gas, some of the contracts that they've won. And we still believe we can keep that over a long term up to 8% to 10% over a long-term period versus their 6%, which was more over the past decade growth that we've stated previously.

And then from the channel perspective, we would expect to begin in the fourth quarter. We're working through the process now in the evaluation that we select.

Is that on a global basis or do you start on -- in certain regions first?

It would be -- it's with a big global distributor, so I would expect that you'd see the earliest impact in the U.S. and Europe.

Great. And then just 2 quick follow-up questions. Just so I'm clear, all of Deutsch is going into the Aerospace, Defense & Marine line or is it going to be spread out a little bit into the auto as well?

It's in the Transportation segment, which part of that is Aerospace, Defense & Marine and part of it is Automotive. The Industrial Transportation piece goes into Automotive.

And, Steve, just to let you know, that 60% of Deutsch goes into Industrial Transportation which, as we reported, is Automotive. And the remainder would go into the Aerospace and Defense piece.

And then very last question, just do you have a combined D&A estimate for the quarter, Terrence? I might have missed that but...

For Deutsch, for next quarter, that will be about $20 million of D&A, both as our current estimate in quarter 3 and quarter 4 for Deutsch as we ramp up the purchase accounting.

And next, we'll go to the line of Matt Sheerin with Stifel, Nicolaus.

I know that you put some selective price increases through in the last quarter or so. Was that successful and sticking? And did that help margins at all in the quarter?

Most of the pricing was done earlier than that. I mean, there is -- it's -- there is a catch-up effect, depending on the terms on your contracts and the timing. So a little bit, but the majority of that came late last year.

Okay. And looking at the recent divestitures. As you look at the business and the various moving parts, is there anything else that you're looking at in terms of divesting here and that, I guess, segues into your long-term commitment to the Subsea cable business, which is obviously not as synergistic as the rest of the business?

There's not anything else that's active. I mean, we appropriately evaluate the portfolio regularly. As far as Subsea goes, I like that business a lot. I think we like that business a lot because we're the world leader in it and it's not easy to get those kind of positions. It's been a bit of a down cycle now, but it's still a good business even in the down cycle. And as you know, when the up cycle comes, it's a fabulous business. So no, that's -- no plans for Subsea.

Next question comes from the line of Sherri Scribner with Deutsche Bank.

I wanted to get a sense -- I think you had some comments about the inventory correction. Maybe we're starting to see a bottom, but we need to see demand pick up in the channel. I wanted to get a sense from you what you're hearing from your channel partners. Have you started to see a pickup in the channel at this point? Or is that more expectations that we'll see pick up as we move through the rest of the year?

Yes, we have. And I think it's still more driven by the customers of the channel partner, the end customers' inventories coming back in line and therefore, the channel inventories come back online. But yes, we have seen sequential growth in this current quarter, and we expect it in the third quarter.

Okay. And then in terms of the guidance for the fiscal third quarter, it looks like you're expecting pretty strong growth across the board. Clearly in Transportation, you'll benefit from the Deutsch acquisition but also in networking and CIS of 8% to 9%. What is giving you the confidence that we'll see that type of growth? Are you -- do you have strong orders in terms of customer forecast? Are you starting to see a pickup thus far into the quarter? But what really gives you that confidence?

It's the orders of the last couple of months. So the order rate picked up as we expected it in the middle of the second quarter and has been tracking, largely tracking to the third quarter. And you're right, most of the pickup is in CIS and in networks. And there's a pretty significant seasonal pattern to network because energy and telecom is really a business that's mostly outside, so there's always a seasonal pickup there. And CIS is -- much of anything, you've got a little bit of an end demand pickup but you do have the benefit of inventories not correcting anymore. So that -- those are the 2 big things. I think if you were to take the benefit of the inventory not correcting out, you would have seen a higher second quarter revenue and a lower ramp in the third quarter. But the order rates through April so far are running just about this level.

Next question comes from the line of Mike Wood with Macquarie Capital.

I know it's fiscal, but can you give color in terms of the outperformance that you had in organic auto growth versus vehicle production? And maybe how much you'd attribute this to content in like vehicles versus the mix from higher price points in cars?

I'd say it's really 3 things. It's -- it is content continuing to grow. It is mix. So as I mentioned about China, for example, a little bit of mix. And it is share from -- when things were of that in '09, we kept investing in engineering, and we're really seeing the benefits across the world, especially in the U.S. when we -- we've always been really, really strong in Europe and Asia. And because of the U.S. automakers, for most of their existence that captive -- connector suppliers, so we had been chipping away at that share and invested in the down times, and that's paying off. So it's split to kind of those 3 reasons.

Okay. And is there any mixed shift to your positive or negative from the relatively weaker trends in Europe either via share or content?

Not material.

Final question today comes from the line of Anthony Kure with KeyBanc.

Just wanted to delve a little bit into the telecom carrier spending. Obviously, what you're looking for in the second half has been pretty well discussed. But looking at CapEx trends, I think from the carriers, at least in the U.S., generally flat year-over-year. And as you think about what happened last year and the spending trends this year, and then just given sort of the secular trends of data sort of flooding these markets, can you just talk about what expectations you have for CapEx trends over the next couple of years in broad terms?

Yes, when you look at that, Tony, number one, like you said, we expect in the second half to be flat year-over-year in North America. And we do expect places like Asia to pick up around NBN. As we look going out, carrier CapEx with the broadband, we expect it'll be slightly up. A lot of that relates to being focused on the broadband deployment on the fiber side. So we continue to think fiber growth of our portfolio in the Telecom Network will grow about double digit. So we still see those trends occurring. Certainly early this year, we took a little bit of pause with some of what was going on in some of the customers in that area. But overall, that's how we see it going out.

I would say longer -- I mean over time, we would expect our business in that area to grow 6% to 8%. If you take what it grew last year and this year, it's going to be on average high teens last year and flat this year. It is a little bit more lumpy business, but the drive for fiber, the need for fiber is, I mean, it's there. There's no -- really no choice, even with the LTE and in many ways, you'd still -- you're going to have more fiber connection points, fibers replacing coax on the antennas up to the towers. So we're still really bullish on this business, and we have a terrific product line.

Gentlemen, if you have any closing remarks?

No. Just want to say thanks, everyone, for joining the call and feel free to call the IR team with any follow-up questions. Thank you.

Ladies and gentlemen, that does conclude our conference for today. We thank you for your participation and for using the AT&T Executive Teleconference. You may now disconnect.