TE Connectivity Ltd. (TEL) Q3 2012 Earnings Report, Transcript and Summary

Ladies and gentlemen, good morning. Thank you for standing by, and welcome to the Fiscal Quarter 3 Earnings Release Meeting. [Operator Instructions] And as a reminder, this conference is being recorded. I would now like to turn the conference over to our host, Vice President of Investor Relations, Mr. Keith Kolstrom. Please go ahead.

Good morning, and thank you for joining our conference call to discuss TE Connectivity's third 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. [Operator Instructions] Now let me turn the call over to Tom for some opening comments.

Thanks, Keith, and good morning, everyone. If you can turn to Slide 3, I'll give you a quick summary of Q3 and an overview of our Q4 outlook. Q3 results were as follows: Sales of $3.5 billion were up 8% sequentially. This was slightly below our expectations, due to further weakening of the euro which had about a negative $50 million effect and a slower-than-expected recovery in our Network Solutions segment. Adjusted operating margin improved 100 basis points sequentially to 14% and very importantly, sequential improvement in all of our segments. Adjusted earnings per share of $0.79 were at the midpoint of our guidance, despite the lower sales. And this is an improvement of 16% sequentially and 4% year-over-year. This year-over-year EPS improvement was on a slight sales decline. Free cash flow is very strong at $414 million and that was up 19% over the prior year. Uncharacterized Q3 for us is a quarter of good execution. Strong cost control and productivity improvement enabled us to improve operating margins back to the 14% level despite lower-than-expected sales. And importantly, margins improved across all segments. In CIS, margins improved 100 basis points sequentially and are essentially at prior year levels on sales that are 12% lower than the prior year. We do expect additional margin improvement in CIS in the fourth quarter. We completed the acquisition of Deutsch in April. The integration is on track and as expected. In Q3, Deutsch added about $0.04 of EPS as expected. We're excited about the opportunities this acquisition will provide. They have excellent products and technology as we've discussed before. We're going to add strong channels, the scale to drive cost down and better customer service, and the results we're seeing are a little better than planned, despite the markets being a little softer. We're very -- we're really excited about the quality of the team that joined TE. And the cash flow, as we mentioned earlier, was very strong and we completed the sale of our Touch and Services business which generated approximately $400 million of proceeds. We entered a little bit on the market environment. We entered the quarter with order momentum building across most of our markets and in particular, in Telecom Networks and our CIS businesses, as the economic outlook was improving in the U.S. Inventories in the channel were back in line, and we experienced a seasonal lift we typically see at this time of the year, especially in our Networks business. So things were tracking pretty much as expected. In mid-May, this momentum began to stall and orders began to soften, especially in Telecom and our Industrial and Appliance businesses. We haven't seen a pronounced decline, but we have seen a softening. Demand in the automotive and commercial aerospace businesses continues to be solid and we are building in the momentum in the consumer business. These trends, coupled with the uncertainty in Europe which is having an impact from a demand and a foreign exchange perspective, and the lower-than-expected growth in China, is resulting in a reduction in our guidance for Q4. I'll go through the details later in the call. I do expect us to maintain our margin in the 13.5% to 14% range in Q4, despite the softness, and to deliver another strong cash flow quarter. We also plan to resume our share repurchase program in Q4, and I'll comment more on capital allocation later. Before we move into the review of our results and outlook, I'd like to recap the organization changes we announced last week, so if you can turn to Slide 4. These changes have been in the planning stage for some time. The regrouping of our business units into these 4 segments had 2 primary objectives. Enabling us to best leverage our capabilities for the customer, and further optimize our efficiency. And we also believe this will provide improved information regarding the performance of the company for our investors. The changes in our segment structure are also enabling several of our top business leaders to get expanded or different roles, which I believe is really great for the organization's vitality and future evolution. The most noteworthy change, for purposes of this call, is Terrence moving into a segment leadership role. I'm really excited for Terrence and the company. And we're also very fortunate to have Bob Hau succeeding Terrence. Bob, most recently was the CFO of Lennox International, and prior to that, was at Honeywell. Bob is a talented financial leader, with strong multi-industry experience and operating skills, and he'll join us in early August. If you can please turn to Slide 5, and I'll talk about our Q3 sales. Total the company sales of $3.5 billion were down 2% year-over-year on an actual basis and down 3% on an organic basis. Currency translation due to the weaker euro, negatively impacted year-on-year growth by 400 basis points or about $143 million, and the Deutsch acquisition contributed $174 million in revenue. On an organic basis, year-over-year, sales increased slightly in Asia, but were offset by broad-based weakness in Europe and continued weakness in the North American telecom market. In Asia, automotive continued to be strong, offsetting softness in our CIS businesses. In China, we had another quarter of double-digit automotive growth, but most other markets were slower than normal. Europe, which accounts for about 1/3 of our total revenue, was down 4% organically from the prior year level and flat sequentially. With the exception of Energy, all of our major businesses were down versus last year. We expect a further slight decline in Europe in Q4, due to the auto seasonal shutdown, and reduced industrial spending at OEMs and in the channel. And in general, Europe has been slow for a while and the decline we had seen has been gradual. Steady, but gradual. In the U.S., our auto business has been strong and demand in our Telecom and SubCom businesses have been weak. On an organic basis, which excludes Deutsch, our U.S. revenue was down year-over-year and up sequentially. We expect similar trends in Q4 with Telecom weakness and a slowdown in Industrial, offsetting another good quarter in auto and commercial aerospace. I'll now turn it over to Terrence to walk through the third quarter results, and then I'll come back to cover the outlook in more detail.

Thanks, Tom, and good morning, everyone. Just before I get started with third quarter performance, I want to remind everyone that the segment reporting changes that Tom mentioned earlier will be effective with the first quarter of fiscal 2013, which begins on September 29. We will report current results in this new structure for the first time, as part of our January 2013 release, and we would expect right now, to file an 8-K with recasted segment historical P&L information by December, which should be well in advance of the January earnings call. Now let me give you some highlights to the key markets in each of our segments. Unless I indicate otherwise, all changes will be on an organic basis, which excludes the effect of currencies and acquisitions. So if you could please turn to Slide 6. In our Transportation Solutions segment, sales increased 13% on an actual basis versus the prior year, and 6% organically. Sequentially, total sales were up 10%, driven by the acquisition of Deutsch which added $174 million in sales in total, and the breakdown of that between our businesses are $96 million in automotive and $78 million within our Aerospace, Defense and Marine unit. Overall in the automotive market, our sales performed as expected, within an organic increase of 7% versus the prior year. Sales were up 22% in Asia and 11% in the Americas. While in Europe, sales were down 4%. Global vehicle production was approximately 20.5 million units in the quarter, which was up 10% compared to the prior year. By region, vehicle production was up 20% in the Americas, 22% in Asia. However, the EMEA region remained soft, with production down 8%. The strong year-over-year growth rates in Asia and North America were once again driven by the rebound following the disaster in Japan, as well as our strong market position. We expect fourth quarter production to be about 19.5 million vehicles, so we're down about 5% sequentially, in line with typical seasonality driven out of Europe. In the Aerospace, Defense and Marine market, sales were flat versus the prior year. Strong demand and increased share in the commercial aerospace and oil and gas markets were offset by declines in the Military market. For the Transportation Solutions overall in the fourth quarter, we expect revenues to be down slightly sequentially, due to the seasonal decline in auto production. Part of our sales that relate to Deutsch are expected to be about $180 million which would be up 4% sequentially versus the third quarter, and is -- which is also high single-digit growth when compared to Deutsch standalone versus its prior year. Please turn to Slide 7, so I can cover our Communications and Industrial Solutions segment. In this segment, total sales declined 12% on an actual basis, and 9% organically versus the prior year. Sequentially, sales were up 8% organically, which was in line with expectations. In the Industrial market, organic sales were down 14% versus the prior year, but were up 5% sequentially. While we did see temporary improvement in quarter 3, customers, both direct and in the channel, became more cautious around mid-quarter. And due to this, and based upon current order trends, we expect quarter 4 in the Industrial market to be down about 10% sequentially. In the DataComm market, which we include sales to the communication equipment, server, storage and wireless equipment markets, our organic sales were down 15% versus last year, due to reduced broadband and wireless spending, particularly with customers in Asia. Sales did show a nice sequential improvement and were up 10%. And in quarter 4, we expect revenues in this market to be similar to quarter 3 levels. In the consumer area, consumer device revenues were down 4% organically versus the prior year, due to continued softness in the PC and consumer electronics markets, that were partially offset by strong growth in both the mobile and tablet markets. Sequentially, our sales grew 9% organically and we expect sales in the fourth quarter to be up 5% to 8% sequentially as well. We are seeing improvement related to the new program wins and new product launches in both the tablet and mobile phone areas. In the Appliance business, we were down 3% versus the prior year, due to soft demand in Asia, which was more than offset by growth in the U.S., and sales grew 8% sequentially in this market. In the fourth quarter, we expect the CIS segment revenues to be down about mid-single digits sequentially, due mainly to normal seasonality and a softer demand from customers in the Industrial and the Appliance businesses. So please turn to Slide 8, and let me get into the Network Solutions segment. Total sales were down 13% on actual rates and down 9% on an organic basis versus the prior year, driven by our Telecom and SubCom businesses. Sales did improve 5% sequentially which was lower than we expected. Organic sales to the Telecom Networks market were down 15% versus the prior year, but up 9% sequentially. Year-over-year declines were once again due to reduced carrier spending in the U.S. and Europe. As I just mentioned, sequentially sales were up about 9% in this market, but that was only about 2/3 of what we have expected. We saw a nice order momentum coming out of our second quarter, the March quarter, but we did see order rates begin to slow in mid-May in the Telecom market, and currently, we expect sales in -- for the fourth quarter to be down about 5% sequentially. Demand in this market, particularly in the U.S. continues to lack consistency. However, the longer-term trends remained attractive, based on the demand for higher speeds and more connected devices. In the Energy market, sales were up 3% versus the prior year, with growth in all regions. And we had 6% growth sequentially. We have seen some of the softness in orders. However, we expect revenues in quarter 4 to be up slightly versus quarter 3, driven by continued investment in distribution, transmission and power generation around the world. In the Enterprise Networks market, our sales were down 2% as data center investment growth was offset by declines in office network spending. And finally, in our SubCom business, our sales declined 21% year-over-year as we expected. We did book about $110 million of projects during the quarter. However, funding of additional order projects continues to be slow. We expect sales in the fourth quarter of approximately $120 million versus our prior expectation of $140 million, due to the push out in these customer fundings. For the fourth quarter overall, Network Solutions sales, we expect to be down slightly on a sequential basis, due to the softness in the Telecom Networks business. Let me now shift to earnings, which start on Slide 9. Our GAAP operating income for the quarter was $371 million, which includes $94 million of charges related to the acquisition of Deutsch and restructuring charges of $25 million. The Deutsch acquisition-related charges include $68 million of noncash fair value purchase accounting adjustments and cash acquisition charges of $26 million. The $26 million is made up of transaction costs of $15 million and restructuring charges related to cost synergies of $11 million. We continue to expect $75 million of total cash charges related to the Deutsch acquisition. About 1/2 of this cash portion will be incurred in 2012, and the remainder in 2013. As Tom mentioned, the Deutsch integration is on track and we expect the EBITDA to exit the year at approximately a 28% level, which is slightly ahead of where we reviewed with you when we did the acquisition plan, when we told you would be about 27% at this time. Looking at adjusted operating income. Adjusted operating income was $490 million in the quarter, with an adjusted operating margin of 14%. This performance is a strong improvement, both in dollars and rate, both year-over-year, as well as sequentially. Both gross and the operating margins were in line with our outlook for the third quarter, despite the lower-than-expected sales in the quarter. The 100 basis-point sequential improvement in operating margin, include an improvement in all segments, driven by the increased volumes and the cost actions that we initiated over the past year in our CIS and Network Solutions segments. As Tom mentioned, we do anticipate revenue levels in the fourth quarter to be down sequentially. However, we do expect operating margins to remain in the 13.5% to 14% level with additional improvement in the CIS segment. Adjusted earnings per share for the quarter were $0.79 and this was up 16% versus the prior quarter, due primarily to the fall through on higher sales and the benefits of our cost and productivity actions. So let's turn to Slide 10. If you look at the top half of the slide, our gross margin in the quarter was in line with guidance at 31% on lower-than-expected volumes due to the cost actions I just mentioned and the operating leverage on the sequential volume growth. We expect gross margins to be in excess of 31% in our fourth quarter. Looking at the bottom half of the slide, operating expenses, as a percentage of sales, were 17% as expected. In quarter 4, we expect research development and engineering, as well as SG&A to be approximately 5% and 12.5% of sales, respectively. Now let me discuss items on the P&L below the operating line. Please turn to Slide 11. Net interest expense was $42 million, up from $37 million in the second quarter, due to a full quarter of interest on the debt that we issued related to 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, again in the fourth quarter, before being reduced in 2013 by about $8 million per quarter, once we pay down the October maturity. We expect a net interest expense of approximately $40 million -- $41 million in the fourth quarter. Adjusted other income, which relates to our tax sharing agreement was $9 million. And in quarter 4, we expect other income of approximately $11 million. The GAAP effective tax rate was 25% in the quarter, and the adjusted effective tax rate was 26%, which was in line with our guidance and we expect the adjusted tax rate to be about 26% again, in the fourth quarter. Now, let me turn to free cash flow and working capital that starts on Slide 12. Our free cash flow in the second quarter was $414 million, a very strong result, and up 19% compared to last year. Cash from operations was just below $500 million. And with the strong year-to-date performance, we now expect our free cash flow to exceed $1.3 billion in 2012. At this level, free cash flow will exceed our long-term target of 100% this year. Capital spending during the quarter was $115 million. And for the full year, we expect capital spending of approximately 4% of sales, in line with our long-term expectations of 4% to 5% of sales. Working capital performance in the quarter was very strong and levels are in line with our expectations. Receivable days outstandings were 62 days and inventory days on hand, reduced to 66 days. The inventory days are a 5-day sequential improvement, and I believe we've done a very good job managing our working capital in this uncertain environment. If you could please turn to Slide 13. Let me discuss sources and uses of cash outside of free cash flow. We began the quarter with $2.9 billion of cash and ended the quarter with $1.3 billion. During the quarter, we paid dividends of $90 million which reflect the 17% increase to $0.21 per share per quarter, and we used $2 billion in April to acquire Deutsch. And when you look at this slide, the $2 billion is shown, both in the acquisition line and the repayment of Deutsch debt of $642 million. In addition, we received proceeds of $394 million from the sale of our Touch and Services business. Outstanding debt was $3.76 billion at the end of the quarter, which is down about $200 million from last quarter due to the commercial paper pay down in the quarter. As I mentioned on the last call, we plan to reduce our debt levels to around the $3 billion level in 2013. As Tom mentioned earlier, with the strong free cash flow we expect for the year and the proceeds from our divestitures, we plan to restart our share repurchase program in the fourth quarter. And I want to remind you, that we have $1.5 billion still remaining under our authorization. Before I turn it back to Tom to cover the outlook, I'd also like to very quickly say, I've enjoyed my tenure and time here as TE CFO over the past 6 years, and I'd like to thank everyone, both my finance team, all of our employees, as well as our investors and analysts for their support. I'm very much looking forward to my new role, leading the Industrial Solutions segment and the opportunities that we have in the space, and I'm also confident that Bob Hau will be an excellent CFO going forward. So with that, I'll turn it back over to Tom.

Thank you very much, Terrence. If you turn to Slide 14, I'll talk about what we're seeing in our order trends. As I mentioned earlier, the order rate started to slow around the middle of the third quarter, particularly in CIS and Networks. And right now, orders are continuing to run around the $3.4 billion per quarter rate, which is down about 3% organically versus our last outlook. So what we saw in March and April were orders running in the $3.6 billion range, slightly higher. And then it began to soften. And as we all know, there's a great deal of uncertainty in most markets, particularly as it relates to the weak economy in Europe. In our Transportation segment, book-to-bill was 1.01. Orders continued to be solid with steady demand in the automotive and commercial aerospace markets. In CIS, book-to-bill was 0.97, with particular softness noted in the Industrial business and in the distribution channel, as customers continue to be very cautious. In Network Solutions, excluding SubCom, book-to-bill was 0.99. But spending by telecom carriers continues to be less predictable and below expected levels. The net of all this is demand in our Telecom businesses, including SubCom, is at one of the lowest levels in several years due primarily to the slow global economy. We're the leading provider of fiber connectivity. And based on the fundamental bandwidth expansion needs, we believe this -- the long-term growth of this market is going to be in the mid to high single-digit range. And we very much earn a strong position to capitalize on this growth. If you turn to Page 15 or Slide 15, I'll cover the current outlook. For the fourth quarter, we expect our sales to be in the range of $3.325 billion to $3.425 billion, which is down 2% to 5% sequentially. EPS are expected to be $0.72 to $0.76 per share, or down or 4% to 9% sequentially. Versus our prior guidance, the difference is due to a weaker economic outlook, a weak Telecom market, and the weakness in Europe and the continuing weakening euro. The euro itself is causing a decline of about $80 million in sales and a negative $0.02 earnings per share impact. If you turn to Slide 16 for our full year outlook. Full year sales are expected to be $13.25 billion to $13.35 billion, which is down slightly versus 2011 on an organic basis. Earnings are expected to be $2.82 to $2.86, also down slightly versus 2011 adjusted earnings per share of $2.95, excluding the extra week that we had in 2011. The euro has created about a 300 basis-point headwind to our overall sales growth, compared to last year, and about a $0.09 negative impact. A few final thoughts before we open it up for Q&A. It is clearly a challenging economic environment, but I think you can see where we're holding the operating margins, that we're taking the appropriate action. I continue to feel really good about our portfolio, the range of connectivity products and solutions we offer. We did make 2 big acquisitions over the last year and a half to become the leader in fiber optic connectivity and to become one of the top 2 players in hours activity, and I really think the integrations are going well. The synergies are on or ahead of plan, and this is just going to make us a stronger company for the long time. And at the same time, we continue to focus the portfolio, most recently with the divestiture of the Touch and Services business. We're getting back on track in tablets and smartphones. A small part of our business still, but we have a little momentum there. And in -- really importantly, our operating leverage is -- leverage continues to improve. And within that, as we mentioned, CIS margins are picking up momentum again, with 2 quarters in a row improvement and we expect Q4 to be at the third quarter. When you look at performance versus 2011 on a 52-week basis, second half margin will be about 50 basis points higher this year, and EPS will be about equal with the second half of 2011 on sales that are 3% lower. So again, we're managing the middle of the P&L very well in my opinion. And second half EPS will be up about 17% versus the first half of 2012. And I think our strong suit, which is our cash flow, it's going to continue to get stronger. And as Terrence mentioned, we'll start regular share repurchases this quarter. Just a little more comment on capital allocation. We're pretty much completing our first 5 years since we separated. And in that time, we generated over $7 billion of free cash flow. We used about $4.4 billion of that for return on capital and about $3.4 billion for M&A. So the ratio is about 55%, 45% return on capital. And our priorities were to #1, strengthen the needs of the company and make sure that the strategic position of the company got stronger. And of course secondly, any capital we didn't use for that, to make sure we return promptly to the shareholders. When I look forward, our priorities are going to change. I think #1 will be a consistent return of capital. We'll continue to look for bolt-on M&A in targeted markets, but I think you can think of us kind of a 2/3, capital return, 1/3, reinvest in the company. So I think we're positioned to do that. We like the make up for the portfolio and we certainly expect to get, to continue to generate strong cash flow. I think the bottom line of all that is it's definitely uncertain out there, but we're really confident in our strategy and in our ability to execute well through the challenging environment. So thank you, and now, we'll open it up for Q&A.

[Operator Instructions] Our first question today comes from line of Amit Daryanani with RBC Capital Markets.

I just have 2 questions. Tom, maybe when you look at the operating margin profile, you guys are clearly doing a good job of hitting the 14% target on sub $3.5 billion revenue now. The mix though looks like, of margin to just Transportation has been doing a lot of the heavy lifting. How do you think of margins with the other 2 segments? And could you maybe talk about what gets the other 2 segments to 14% off margins, in terms of for a revenue run rate or for the cost initiative, especially in the Network Solutions side?

Sure. Yes, I think your comment that Transportation has been carrying the load is right. And Networks, I think the issue there is with the bottom of the cycle. We think that I would expect that group of businesses to get back to 15% as the revenue comes up. I think inherently, it's -- the gross margins in that business are good. Some of the highest we have in the company. So it's really a volume, more of a volume issue. Clearly, we continue to drive productivity there. On the CIS, I think it was a combination of 2 things. One, the market softened and the channel correction that happened in the first half of the year, in response to that, we took a lot of cost out. So there's clearly significant cost actions we've taken in that business. And now as revenue -- even though it's not picking up, you can see us improving the margin and we should get significant lift in that business, as the margin -- as the revenue picks up.

And then Tom, maybe I'm reading too much into this. But I think you said, that you guys intend to return 2/3 of the free cash flow back to shareholders. That seems a high number at 67%. Whereas in the past, you've talked about 50% to 60%. Could you verify that? And then would the split between buybacks and dividends change on a go-forward basis?

Well, as I said, we ran about 55, 45 return to M&A in the first 5 years. And if my memory serves me right, about 2/3 of the return was buyback, and 1/3, dividend. So dividend is about $1.4 billion and return's about $2.9 billion in that period. I do think because we've made 2 significant acquisitions that really fill the 2 key strategic areas that by -- almost by definition, going forward, that there'll be much more focus on a consistent return of capital and bolt-on acquisitions. I would never say never, but that's what I say when I think -- when you think in terms of the model, the 55%, the 60% to 70%, is how I think of it as a return. I would expect us to continue to raise the dividend, as long as global economies are sound and our earnings are keeping in line with our target dividend yield. I hope that answers your question.

Our next question comes from line of Matt Sheerin representing Stifel, Nicolaus. Matthew Sheerin - Stifel, Nicolaus & Co., Inc., Research Division: Just a question on the commentary on the CIS business and specifically, the channel softness. Obviously, you went through an inventory correction there. And it sounds like distributors are being more cautious. But what is sell-through look like in inventory levels? Are they bringing down inventories yet again? Or are they just being super cautious here?

Matt, I think it's more of the latter, super cautious. A quarter ago, when we were all together, I think we were feeling cautiously bullish as the inventory correction was over and we saw in Q2, and in Q3 actually, the lift in sequential revenue through the channel and their sell-throughs were going up. But as this slowdown began to happen in mid-May, with U.S. jobs peaking and all those other things, everybody's just starting to dial back a little bit. I don't think the inventory and the channel, a problem. I think just that -- what we've gone through over the last 5 years, a couple of times collectively, everybody is managing that much more closely, and including ourselves, where our inventory days are actually down this quarter. I think it's just -- everybody's a little bit gun-shy. Matthew Sheerin - Stifel, Nicolaus & Co., Inc., Research Division: You're getting the sense that the distribution point-of-sales has weakened as well, going into this quarter?

No. I think the slope is just changed. It was ramping, and now it's flattening, and I think that's just leading the caution. Matthew Sheerin - Stifel, Nicolaus & Co., Inc., Research Division: Okay. And then on the OpEx side, it looks like you're holding margins fairly well, given the volume softness across different parts of your business. If we're in this sort of a component cycle that's stuck here and we continue to see softness, are you looking at other cost-cutting measures, whether it be in CIS or other businesses, particularly networking, where it doesn't look like things have bottomed yet?

I would say, Matt, I think as we proved over the last year, if we do, we will continue to assess where are we from a volume level and we will take actions as appropriate. So I think what you can expect, and I think what you saw, like we did in CIS over the past year -- CIS was an area that we had to adjust it. We're happy that in the third quarter, we're back to prior year OI levels even on lower volume. Essentially in there, we're going to prove it. So we see markets change that fundamentally, we sort of had a higher level that we will take -- we'll evaluate further cost out. So... Matthew Sheerin - Stifel, Nicolaus & Co., Inc., Research Division: It doesn't sound like you're at the point now where you're ready to do that. You feel like things have at least, fabbed -- aren't you getting materially worse? Is that fair or...

I'd say there's not much visibility, Matt, but what we do have is a pretty robust set of alternatives of what we do, depending on the circumstances. And even though, as we entered the second half of the year, we were expecting, I'd say modest recovery and normal seasonality, we weren't -- we kept our cost structure more conservative to that. And that's why, we were able to get the margin to where it is. So that's -- we're taking a very conservative view, not in a way that would hurt our responsiveness to customers. But it's uncertain out there, and so we're managing it accordingly.

And we'll go to the line of Shawn Harrison representing Longbow Research.

I just wanted to talk a little bit about Deutsch. It sounds as if margins are going to be better exiting the year than you anticipated, and high single-digit revenue growth year-over-year. Maybe if you could just speak to where that revenue growth could get over the next 12 months? Can you see it accelerate, given the feedback you're getting from the channel? And then, why is profitability running a little bit better than expected?

I think a couple of things. On the profitability, the teams had been tremendous at getting at the early synergy opportunities ahead of schedule. So that's helped. The revenue is off slightly, and that's economics, but it's still up year-over-year and the business is solid. I'd say it's -- we're not calling next year yet. It's a little outside our window, and we'll talk about that next quarter, but we're very bullish about the business. We do expect that we'll get lift through the channel because they -- especially in their Aerospace and Military business, they didn't really have much there and we bring a lot there. We're the biggest player to those channels. So I mean, we'll definitely be able to help that there and that's part of that channel strength comment before. And I think we'll continue to find more opportunities for cost synergy. Just because of our size, helping them buy materials cheaper, and things like that. So we feel good about it. It's a little bit hard to call the market, the end-demand environment, but -- much like we did with ADC, the end-to-end system we can offer in fiber, we have that end-to-end hours connectivity we can offer into the Industrial and commercial market, every application we can serve. So we're very, very excited about that.

Okay. And then as a follow-up, just with restarting the share purchase program and understanding that you have some debt coming due, how aggressive do think you'll be in terms of repurchasing stock during the fourth quarter?

Well, we're going to get started. As you know, this quarter, I think our main thing is to be consistent within a certain range. And I think that's the thing that -- we have bought back a lot of shares, but when we've made acquisitions, we've turned it off. They were big acquisitions. You can expect us to be consistent in -- and I'd say, think about the 150 to 250 range.

Our next question comes from line of Sherri Scribner with Deutsche Bank.

I just wanted to get a little bit of detail on what you're seeing or what you're hearing from customers in the networking segment, and clearly there's lots of long-term demand drivers, but as you've noted in that segment, it continues to be weak. Do you have any sense from your customers about when they expect to see a pickup in that market?

Yes. We talk to them regularly. I think it really -- it's a customer-by-customer situation in that business. Last year, Europe was very strong, for example, and the customers were more aggressive even than we thought. This year, they've turned that back. I think it's some of that uncertainty. In the U.S., it started very slow because of all the strategic activities that was going on in the U.S. telecom market. So we have seen the U.S. pick up. It's just not anywhere near the rate, and it was slow last year in the second half. So I think it was a combination of caution, as well as -- if I'm going to spend a little more capital, and I believe that at -- overall, CapEx spending is down, a little more going into the wireless versus the fiber, right now. That's not unusual a few years back. The big push in the fiber to the home, or fiber deep into the premise-type program, those have slowed down. No surprise. We fully expected that. So it's really a case-by-case. And we've seen China slow a bit. It was very strong for us last year, slowing down this year.

Okay, great. That's helpful. And then in terms of the consumer business, consumer devices. That has been a segment where you've been struggling. This quarter, you mentioned PC's down, but you said tablets were a bit better. Can you give us a little more detail? And do you think you're gaining share in that market?

I think we're growing with the market now, Sherri. I think, as you know, we had -- before the double whammy, the customers -- our customers that were losing share, we were strong with them. We hadn't established with the customers that are winning share. So in the last year, it's been about stabilizing the business, both from a top line and a market position and a cost perspective. I think our team has done a tremendous job of doing that. And now we have, we've won several important programs that should -- I used to call it a beach head. I think it's more than a beach head for us now. Still a small part of our business. But this last quarter, in terms of the programs you want and the orders we got, we show good [ph]. So I'd say we're now growing with the market, and that tablet and smartphone market is growing 40% to 50% or 30% to 40%, something like that, and we're finally growing with that, even though it's a small part of our business. So for us, the proof point is, we can serve these customers. We have the technology, and we can get more than 1 or 2 wins. We still have to build on that.

Our next question comes from Jim Suva, representing Citi.

This is actually Samuel Meehan, on behalf of Jim Suva. I want to get a couple more details about Europe. When you look at the weakness in Europe, European automotive, have you seen any mixed shifts or model push outs that would have a significant impact on content dollars per vehicle?

No. Not really. I'd say the strength is still in the high end and a lot of that is exported from Germany to the U.S. and China, and that part is still robust. Most of the weakness is in the Southern Europe OEMs. So we have not seen any negative shifts in content because of mix of cars.

Now we have a question from Wamsi Mohan with Bank of America.

This is Ruplu filling in for Wamsi. Just -- you've talked about the margins and transport connectivity. I just wanted to touch on that again. Some margins improved quite a bit, 140 basis points sequentially. How much of that was Deutsch and how do you see -- how should we think about margins going into the September quarter? Do you think you can maintain that higher margin?

#1, Deutsch as we talked on our last call, both in Transportation as well as the total company, is about 10 to 20 basis points of NOI benefit. So when you look at that part of the question -- when you look at the fourth quarter because we will have seasonal slowdown in Europe, we do participate in the shutdowns that the OEMs have. We do expect our margin in Transportation to be about 16% in the fourth quarter. I think when you look at what's offsetting that, we do expect a further improvement in our CIS segment, going the other way, that helps us to cost improvements that we've had there in CIS. The combination is going to allow us to keep our margin up in that 13.5% to 14% level, Ruplu.

Okay, got it. Just as a follow-up on subsea. I see you've lowered the guidance a little bit from 5 20 to 4 90 for the full year. Last quarter, you talked about one contract coming in later this year. Is that the contract that is being pushed out? And you also mentioned something about $110 million. When did those come into revenue?

If you look at that, Ruplu, the 110 we booked during the quarter was actually a number of smaller projects, really in the oil and gas area. The one project that we've talked about last fall, you're correct. That customer has not completed his funding yet and that's really why the revenue is down from the 140 that we expected last quarter, in fourth quarter, down to the 120. The 110 that we'd talked about, they will be contracts that start up next year and it will be as part of next year.

Again, we have a question from Amitabh Passi with UBS.

This is Jim Hillier for Amitabh. I was hoping in light of some of the macro trends, you can provide us any color on the current pricing environment as well as how lead times are currently trending?

Pricing overall I'd say, not any big change. I mean, I think there's always pricing pressure in the business. But we're not seeing any unusual pressure. It always feels like a lot of pressure. But nothing unusual here. So I think we'll continue to be in that -- I'd expect to be, plus or minus at 2% price erosion range.

And on lead times, lead times have been at normal levels. I mean, certainly on certain products for certain customers and applications, that's specific, but on an overall basis, you look at our lead times, there's no extension or contraction of them. They've been at normal levels for most of this year.

I think what we see more is just change orders. A little more frequent. So it's people waiting, waiting to buy until they get a little more sure. So it's not so much that the fundamental lead times are reducing, but we do see a little more churn in the order.

Okay. And if I could also follow-up on your telco business. It appears that while spending has been weak, if look at the budget outlooks for some of the major North American carriers, spending looks more back half-weighted this year. And from your customer conversations, do you think that ultimately we could see some improvement in this business by year end? And also as a follow-on to that, if you any update on the NBN ramp, that would be really helpful.

Say, for us, we're only 2 months away from our year end. So could there be, yes. I'd say the general feedback has been it's coming. It's coming. And it's been a little slower than obviously, than we expected. Could it happen by the end of the calendar year? I mean, our fundamental view is that pent-up demand is happening because of this. Because you still have to be able to invest more in the wireless part. You still have to get the signal in the ground to have the coverage and the capacity really work. So I'd say we expect the investment to pick up in our portion of the network, but it's hard to call the timing right now. I mean, a quarter ago, we were feeling pretty good in seeing the ramp, that it was our Q3 and Q4 which would have been the June and September quarters. We got half of what we expected in Q3 and it's not going to -- right now, our call is that it's not going to happen in Q4.

And on your NBN -- NBN for our 2012 is about $20 million. We're going to -- we started to get some of that program, started to ramp here on our quarter 3. A similar amount in quarter 4. Next year, right now, we would expect that to increase up to $50 million, $60 million, as that program continues to ramp.

And our next question comes from the line of Mike Wood with Macquarie Capital.

Tom, with the recent management changes, are you expecting any sort of -- after everyone takes over and gets set in the job, are they supposed to come back with cost savings initiatives or growth initiatives, investment suggestions?

We always expect that. I think with this -- look, I think we'll get some fresh looks at things. Right? But all these 4 leaders have been in the company from anywhere from 3 to 25 years. So they may know the company pretty well. We -- they've been part of the senior team for several years now. So they understand even the business they're going into, while it may be new for them to run, they understand it pretty well. So -- but I do think that my comment on vitality, and what I mean by that is, it's good when people shift around, especially if it's not that disruptive because they've been around and they already know the business. So I do expect to get new ideas. Absolutely. I don't expect us to turn the place upside down, as a result of it. But I do expect that we're going to be stronger as a result of these changes.

Okay. And on the Transportation side, your orders were above the growth of global OEM production. Your sales reported were slightly below that. Has that segment also been impacted by the destocking that you'd mentioned, just given the uncertainty ahead of the plant shutdowns in Europe?

No. No. Really, Mike, when you look at it, what you saw in the third quarter of our sales being a little bit less in production, really just due to our Asia content per vehicle and what we've got in Japan, just being such a weight on the production growth. In the fourth quarter, we expect our sales to be greater than production and we expect it to be that way for the year. So it's really just how the production builds were going around the world.

And we will go to the line of Mike Wherley with Janney Capital.

I just wanted to ask on the restructuring. So you're not talking about any further actions right now. But the restructuring that you've already done, is that going to roll through immediately in the fiscal fourth quarter? Or will it be more of a fiscal 2013 event?

Most of the restructuring has to do with the Deutsch integrations. So when you look at that, it mainly relates to Deutsch and the integration of Deutsch into our structure. That will come in the relationship as we have the Deutsch integration. There are some tailing items that are coming. But most of those costs are already in, or will be in, in the fourth quarter. So some of those costs you see are tails related to prior actions.

Okay, so in the CIS segment, for example, is the benefit already being realized in the third quarter? Or will there be some upside in the fourth quarter?

As I've said, we do expect CIS margin to go up sequentially. There is a little bit more benefit because the volume's coming down. But there will be a little bit of benefit in the fourth quarter.

Okay. And then just on the smartphone and tablet commentary. Are you getting on to more platforms? I mean, I know you mentioned a few wins. But is it about a broader set of customers? Or is it more content uptake on each platform that's sort of helping you out there? Which is it more?

It's more customers. It's a couple of customers we really haven't had much of a position with, and now we have a starting position with them. So we have more customers in a broader way and in a deeper way than we did a year ago, is the way I think about it.

Next, we'll go to the line of Craig Hettenbach with Goldman Sachs.

Tom, you mentioned -- or commented on the stable trends in the automotive market. Can you talk about just how suppliers and customers are managing inventory through this environment? Did you see any type of change through the quarter?

No. I think -- I mean, everybody is tight. Where we see it is, as I kind of mentioned earlier, a little more churn in the releasing of orders. So which -- I think it's typical. Right now, in Europe, we're going into the shutdown season. So the Southern OEMs are going to shut down for more than normal, but that's no surprise. We've been expecting and planning that for months. I think it will be kind of a normal shutdown in the North. But inventory levels, whether on the lot or in the channel, seem to be in pretty good shape, and our inventory levels are in good shape.

Got it. And then if I could just follow up on the smartphone and tablet piece, you commented, you think you now have a beach head. Any thoughts around the types of technology? I know you've done antennas, how the kind of connectors fit in, and is there an opportunity to kind of expand your content on programs as you go forward?

I think there's an opportunity to expand it, but within the products that we know best. So right now, our focus is on the key things we do, antennas connect, and connecting systems. So -- no, we're not -- not to say we will never stray from that, but I think there's just so much opportunity as we continue to get better. The good news is we have the technology. We have the products. It's for us. It's -- our problem in the past has been more about execution and the pace of execution, and we're really improving that. And now we have to build a track record. We earn a couple of programs, do well, and then we earn a few more. And that's the way we're -- the approach we're taking.

Okay, and how much -- I know you guys have talked about the management change about a year ago, in terms of the customer interface and things like that, how much has that come into play, in terms of the ability to gain traction now?

The changes we did with our channel?

In consumer.

In consumer, I'm sorry. That's helped a lot. Organizing around the vertical markets which -- it took us a while to take the CIS and break it into these global vertical businesses. But it's -- one of the first we did was consumer and that has made a massive difference, as well as the leadership that's in that group. So they've made all the difference in the world. We have better customer intimacy and relationships and we're executing better. And we just have to keep doing it.

And next, we go to the line of Anthony Kure with KeyBanc.

Just a couple of quick ones. Can you just talk about China, specifically how it progressed through the quarter, and if you saw any inflection points, maybe to the negative and then any change in that, relatively recently, just maybe talk about the linearity of China through the quarter if possible?

I think China has been steady, but slower than we thought. When we sat there a quarter ago, we would have been expecting, and as you know, the government was keeping interest rates up, trying to cool things off, trying to cut back on some of the speculation in housing that was going on and trying to head that off and of course, balance that with economic growth. We saw that for sure, the first 2 quarters. We thought by the third quarter, that, that would begin to pass and that stimulus would happen. Now, there's still applying stimulus. It was announced and things like that, but we haven't really seen it pick up. Auto has been still very robust, although slowing a little bit slower than it's -- for sure, than it has the last couple of years, but still high. 15%, 18% for us. But a lot of our other businesses are flat to -- even slight. In some cases, slightly down. Now, some of that, is the exports are down because of Europe and U.S. But it's -- I haven't seen an inflection point. No. I'd say our people on the ground there expect things to get better because of what the government is saying. But it's hard to call.

Okay. That's helpful color. And I guess in a similar vein, instead of China, maybe on the enterprise IT market, I'm just hearing consistently now that the sea level folks make -- the decision makers here are really taking a sharper eye on budgets in the second half of the calendar year. I'm just wondering, is that -- are you seeing that? And has that had any differences among the geographies, either better or worse?

I'd say we're seeing it pretty broad-based. That second quarter to third quarter, our business that serves those markets picked up, recent sequential pickup, we would have expected that. Again, go back 3 months, we would have expect some sequential pickup in Q4. We don't expect that now in this outlook. So I agree with you. We're feeling that as well.

And we have a follow-up from Amit Daryanani with RBC Capital Markets.

I just want to maybe talk a little bit about the commodity cost, how that's playing out in the September quarter and your progress there? And then secondly, given the fact that FX has been a fairly severe revenue and to some degree, and EPS headwind for you guys this year. Any confidence on a hedged FX on a rolling 12-month basis that you guys come up with annual guidance?

Amit, it's Terrence. So 2 things. Let me take the second piece first. So #1, we do hedge transactionally. We don't hedge translationally. I mean, you are right if you look at this year. It is a significant headwind that we're dealing with, almost $400 million with the euro weakening. I don't see us changing our policy around hedging translation because of -- our earnings are also hedged because that translation comes through at the OI margin. When you look at metals. Metals is a slight benefit right now. As you know, we have a risk management process that we do on how we fix. So really when you look at it, metals are a slight benefit, not significant due to the position we put in place when copper and gold and silver were a little bit higher. So we're relatively fixed out for the next 6 to 9 months pretty firmly. There may be some benefit if metals stay where they are and later next year. But right now, it's pretty minor benefit.

And it goes on the metal hedging. It's still a rolling kind of 2 quarter-out process, right?

It actually goes out 18 months. But the more current it is, the heavier we are fixed from a ratio of what we buy, and then it sort of goes out overtime. But you're right, it's a rolling 18-month program.

This is Tom. Before we cut off the call. Just a few closing comments or 1 closing comment. Terrence and I have been together since we separated in the year before that in the business, and it's been -- for me, it's been fantastic. Many of you, if not all of you out there have had the opportunity to deal with Terrence and the consummate Pro. A guy who loves, and committed to the company, and he's made it a lot better. And in his new role, he's going to make it even better. So I know, it's not easy for him to unplug from this part of the job. But boy, I'll tell you, he's done a good job. He's left our organization in great shape. He's been integral in recruiting a tremendous successor. And he's going to take this other business, in my mind no question, to another level. So thank you, Terrence for everything you've done. And thanks, everybody, on the call. I appreciate it.

Thank you, everyone.

Thanks for joining our call. Please feel free to follow up with the IR team, with any follow-up questions. Thanks.

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