TE Connectivity Ltd. (TEL) Q1 2019 Earnings Report, Transcript and Summary

Ladies and gentlemen thank you for standing by. Welcome to the TE Connectivity First Quarter 2019 Earnings Conference Call. [Operator Instructions] As a reminder this conference is being recorded. I would now like to turn the conference over to your host Vice President of Investor Relations, Sujal Shah. Please go ahead.

Good morning and thank you for joining our conference call to discuss TE Connectivity's first quarter results. With me today are Chief Executive Officer, Terrence Curtin; and Chief Financial Officer, Heath Mitts. During this call, we will be providing certain forward-looking information, and we ask you to review the forward-looking cautionary statements included in today's press release. In addition, we will use certain non-GAAP measures in our discussion this morning, 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. Note that all remarks on today's call will reflect TE continuing operations. We completed the sale of our SubCom business during our first quarter and it is reflected as discontinued operations and not included in our results or guidance. Finally, due to the increasing number of participants on the Q&A portion of today's call, we’re asking everyone to limit themselves to one question to make sure we can give everyone an opportunity to ask questions during the allotted time. We're willing to take follow-up questions, but ask that you rejoin the queue if you have a second question. Now let me turn the call over to Terrence, for opening comments.

Thanks Sujal and thank you everyone for joining us today to cover our first quarter results and our revised outlook for 2019. Before I get into the slides, I’m going to provide an overview of the key messages in today's call. First off, I am very pleased with our results in our first quarter. We delivered revenue, the midpoint of our guidance and adjusted earnings per share at the high end of our guidance range in a market that continued to soften through the quarter. Our results reflected resiliency, as well as the diversity of our portfolio, with our Industrial and Communications segments, offsetting lower than expected sales and transportation. And while our quarter one results demonstrated solid execution, softer market conditions are resulting in us having to reduce our outlook for the rest of our fiscal year. I want to stress that the change in our guidance versus our prior view is entirely due to market softness that we're experiencing and if you look at this change by region, it is primarily driven by China, along with a slower global auto production environment than we anticipated 90 days ago. We continue to be focused on content growth outperform these slower markets, while we execute on other non-growth levers in our business model to drive improvements and profitability as we'll move through this year. And with this on the backdrop, let me tell you how we’re thinking about financial success in 2019. As I just mentioned, we have a portfolio with content growth opportunities that will allow us to outgrow, as well as partially buffer the weaker market conditions we're seeing. We remain committed to our long term business model, we’ll pull the non-growth levers to improve margin and EPS, while ensuring we invest in long term opportunities to drive future content growth. When we look at earnings power, we expect to demonstrate earnings per share performance in the second half of 2019 that is above our exit rate in fiscal 2018, while absorbing the FX headwinds we're experiencing and that we'll talk about in the call. And finally we believe this huge success will position the company to be backed the business model performance which we've demonstrated over the past two years when markets return to growth. So with that as a backdrop let me get in the slide and I'll get into more details and highlight the quarter on Slide 3. Sales during the first quarter were $3.35 billion which was flat year-over-year on a reported basis and up 2% organically, driven by 5% growth in both our Industrial and Communication segments. In Transportation, our sales were flat organically with a slight decline in auto revenue being offset by growth in commercial, transportation and sensors. Global auto production was down 7% in the first quarter, well below our guidance expectations. In auto, our sales were down only 1% on an organic basis compared to that 7% decline in production. And it demonstrates the resiliency of content growth in our auto business even on a top production environment. In the quarter we delivered 16.9% adjusted operating margins. Our revenue was down over $160 million sequentially as expected and I'm pleased that we could maintain operating margins that were essentially flat from our 2018 exit rate on a much lower sales volume. Adjusted earnings per share was a $1.29 in the quarter which was at a high end of the guidance. From a free cash flow perspective, during the quarter we generated $69 million, which was in line with our expectations in similar to quarter one of last year and we returned $645 million to shareholders through dividends and share repurchases in the quarter. Now, let me turn from the first quarter and talk about our revised outlook. Back in October when we issued guidance for the year, we highlighted that we were entering a slower market environment. During the first quarter, our order trends were below our expectations with weaker global oil production, and lower order levels in China in our Transportation and Communication segments. Our overall orders in the first quarter were down 4% sequentially and on a year-over-year basis total orders were down 6% with China orders declining over 20%. Based upon these trends, we now expect fiscal year sales at the midpoint of $13.65 billion versus our prior guidance of $14.1 billion. Versus our prior view, this is a change of $450 million at the midpoint in revenue. This reduction is primarily driven by China with some weakness in European auto as well. If you look at the change by segment, approximately two-thirds of the reduction is in transportation with the remaining primarily in communications as both transportation and communications are being impacted by the weakness in China. In our Transportation segment, we are now assuming that global auto production will decline 4% to 5% in our fiscal year compared to our prior outlook of flat production in our fiscal year. Our expectation for the industrial segment are consistent with our prior view with the ongoing strength that we're experiencing in the end markets specifically commercial, air, defense as well as medical. With this revised sales outlook, we are adjusting our earnings per share is now expected to be $5.45 at the midpoint, and this is a reduction of $0.25 from our prior view. This change in our EPS guidance is entirely driven by the market change and the headwind on currency exchange effects that we highlighted last quarter remains essentially unchanged at $375 million in sales and $0.16 on EPS. So if you could please turn to Slide 4, let's look at order trends. On this chart, you can find the details. But I want to highlight what has changed over the past 90 days. As I mentioned earlier, orders were below our expectations. When we got it 90 days ago, we were expecting that our orders in quarter 1 would be similar to our quarter 4 levels at $3.5 billion. But instead, orders declined sequentially by 4% and our book-to-bill in the quarter remained at 0.99. On a year-over-year basis, organic orders were down 4% driven by declines in China of 22%, as well declines in Europe of 6% partially offset by growth in North America of 7%. By segment, you can see on the slide we continue to see strong industrial orders that continue to support our growth outlook that is consistent with our prior view. However, as you can see in transportation and communications, you can see the weakness we’ve experienced in orders which relate primarily to China and that's impacting our outlook. So let me get into things by segment and if you could turn to Slide 5 I will start with transportation. Transportation sales were flat organically year-over-year. Our auto sales were down 1% organically versus auto production declines of 7% in our first fiscal quarter, and this was well below our production assumption that we expected when we guided. We did see growth in the Americans which was offset by lower sales in China and Europe. China auto production was especially weak and it declined 15% year-over-year much worse than we expected. Even in this weaker environment, the 7% decline in auto production our results driven forcibly outperform auto production. In commercial transportation, we have been expecting growth to moderate from the strengths we've had in the prior years. During the quarter we grew 2% organically versus markets that declined 7% driven by China, and our growth in this area also continues to be driven by content and share gains. In our sensors business we grew 4% organically year-over-year with growth driven by industrial applications, and in auto sensors we continue to increase our design win value across a broad spectrum of sensor technologies and applications. Adjusted operating margins for the segment were 17.9%, this was essentially flat sequentially as we expected. In 2018 as we discussed with you, we increased investments to support strong pipeline and new design wins including those in electric vehicle and autonomous driving applications. With production falling considerably both in China as well as in Europe, we are continuing to balance near-term margin performance with long term growth opportunities and while we're running currently below our target margin levels in this segment, we expect that cost actions that we will be taking to enable our margins back to the target levels. Let me turn over to industrial solutions and that's on Slide 6. Industrial segment sales grew 5% organically year-over-year as expected with growth across aerospace, defense, as well in our energy business. Aerospace, defense and marine business delivered strong 13% organic growth with double-digit growth across each of its businesses. In commercial aerospace, growth was driven by content expansion and share gains and the ramp of new platforms and in defense over the past year, we've seen nice growth here being driven by favorable market, as well as some new product cycles. In industrial equipment, our sales were down 1% organically with strength in medical offset by the expected deceleration in factory automation. And lastly, our energy business grew 6% on an organic basis driven by growth in North America. Adjusted operating margins for the segments expanded 60 basis points to 14.9% and was in line with our expectation. Our plans continue to remain on track to optimize our factory footprint in the industrial segment to expand the adjusted operating margins to the high teens over time. So please turn to Slide 7 and I’ll get into our Communications segment. Communications grew 5% organically as expected with strong growth in data devices being partially offset by appliances. Data and devices grew 9% organically with growth being driven by high-speed connectivity and data center applications. Our appliance business was down 2% organically due to weakness across Asia, partially offset by growth in North America. Adjusted operating margin for the segment was 16.4% in line with our expectations. Before I get into guidance in more detail, I'm going to turn it over to Heath to get into more details on the financials in the first quarter.

Thank you, Terence, and good morning, everyone. Please turn to Slide 8, where I’ll provide more details on the Q1 financials. Adjusted operating income was $565 million with an adjusted operating margin of 16.9%. GAAP operating income was $484 million and included $75 million of restructuring and other charges, and $6 million of acquisition charges. As a result of market weakness, we are broadening the scope of our cost initiatives across our business and accelerating cost reduction and factory footprint consolidation plans. You should expect us to aggressively pursue incremental restructuring to reduce our fixed cost structure, while balancing the investment opportunities which enable future growth. And we're confident that with these initiatives, we expect to exit the year with a more nimble cost structure, which will enable future margin expansion and earnings growth. We're currently working through these restructuring options and we'll update our estimates as the year progresses. Adjusted EPS was a $1.29 at the high end of our guidance range and included $0.05 of headwinds from currency and tax rates. GAAP EPS was a $0.11 for the quarter and included restructuring and other charges of $0.16 and acquisition related charges of $0.01. The adjusted effective tax rate in Q1 was 18.1%. And looking ahead, we do expect a slight decline in our tax rate in Q2, for the year, we expect the full-year adjusted effective tax rate to be in the 18% to 19% range. Now if you turn to Slide 9, sales of $3.35 billion were flat year-over-year on a reported basis and up 2% organically. Currency exchange rates negatively impacted sales by $73 million versus the prior year. We expect the full-year impact of currency exchange rates to be $375 million which is consistent with our prior view. Adjusted operating margins were flat sequentially as expected at 16.9%. And as Terrence mentioned earlier, I'm pleased that we could hold operating margins flat in the fourth quarter with over $160 million of sequential revenue decline. We do expect Q2 margins to modestly drop from Q1 levels as we adjust our operations to the lower outlook. In the quarter, cash for continuing operations was $328 million, that's up 16% year-over-year and free cash flows nearly $70 million, which is in line with our typical seasonality with $209 million of net CapEx. Also we returned $645 million to shareholders through dividends and share repurchases in the quarter. And of course this includes the return of proceeds from the sale of our SubCom business that we completed last quarter. As I’ve told you in the past, our balance sheet is healthy and we expect cash flow to be strong, which provides us the ability to provide organic growth investments to drive long-term sustainable growth also allowing us to return capital to shareholders and still pursue bolt-on acquisitions. With that, I will turn the call back over to Terence to cover guidance.

Thanks Heath. And let me start with the second quarter on Slide 10, build on some of the things he said. With the slower market conditions we're experiencing, we do expect quarter two revenues and adjusted earnings per share to be roughly flat with quarter one, certainly building on the orders chart I talked about earlier. Second quarter revenue is expected to be $3.3 billion to $3.4 billion with adjusted earnings per share of a $1.25 to a $1.29 for the quarter. At the midpoint, this represents year-on-year reported and organic sales declines of 6% and 2% respectively. Given the ongoing strength of the U.S. dollar, we do expect year-over-year currency exchange headwinds of approximately a $155 million on the top line and $0.06 to EPS in the second quarter. By segment, we expect Transportation Solutions to be down low single-digits organically. Auto revenue is expected to be down mid-digits organically versus a global decline in auto production of 9%, driven by weakness in both China and Europe. Once again, our top line will outperform versus auto production as it shows the benefit we derive from content. Industrial solutions is expected to grow low-single digits organically with growth in AD and then the medical applications being partially offset by softness in factory automation applications. And we expect a communication segment to be down mid-single digits organically driven by Asia. If you could please turn to the Slide 11 and I'll get into more details on the full year guidance for fiscal 2019. Building on my earlier comments around market and order trends, we expect full year revenue of $13.45 billion to $13.85 billion. This represents flat sales organically and reported sales decline of 2% due to foreign currency exchange headwinds of $375 million. And as I said before this headwind is consistent with our prior view. Adjusted earnings per share is expected to be in the range of $5.35 to $5.55 per share. This guide includes a $0.25 negative impact from both currency exchange rates as well as tax. Excluding these headwinds, adjusted earnings per share would be growing low-single digits at midpoint and a flat organic sales top line. Now let me get some color on our segments for the full-year. We expect our Transportation Solution segment to be flat organically. We also expect auto sales to be flat organically with content growth enabling outperformance to offset 45% decline in global auto production. When we look at global auto production to be now 45%, we expect auto production in China to be down 10% in our fiscal year, Europe to be down mid-single digits, and North America to remain roughly flat. And when you think about, this is reflects our assumption that global production and units will remain around quarter one production levels which was around 22 million vehicles per quarter throughout our fiscal year. We are also expecting continued growth in sensors in both industrial and auto applications driven by the ramp of the new auto design wins that we've talked to you about. In Industrial Solutions, our outlook is unchanged from our prior view. We expect sales to be up low single-digit organically with growth driven by aerospace, defense and medical applications, and clearly our 6% order growth in the first quarter support is unchanged the outlook. In Communications, we expect to be down low single-digits organically, driven by Asia markets in both data and devices, as well as an appliance. So, as before we go to questions, let me just summarize some of the key takeaways and I'll reiterate some of the things I said at the front end. In the first quarter, you saw the positive impact of our diverse portfolio with revenue and EPS in line with guidance in quarter one, despite a soft marketing from our kind of motorman. I’ll revise 2019 guidance is driven entirely by weaker markets. This is primarily driven by China with some weakness in European auto as well and by segment, approximately two-thirds of the reduction is in Transportation with the remaining in Communications. We also remain committed to our long term business model and we're going to be pulling the non-growth levers to respond to market conditions. When we have seen weaker markets in the past, we have taken advantage of the opportunity to aggressively go after cost reduction and consolidation activities, and we plan to follow the same approach and emerge with increased earning powers when markets return to growth. And as I stated upfront, we expect to demonstrate earnings per share performance in our second half that is above our exit rate in fiscal 2018 even with our revised sales outlook. We are focused on ensuring the company will be back to business model performance when markets return to growth. And lastly, before I close, I do want to thank our employees across the world for their execution in the first quarter, and also their continued commitment not only to TE, but also our customers and a future that is safer, sustainable, productive and connected. So with that, Sujal, let’s open now for questions.

All right. Thank you, Terrence. Craig, could you please give the instructions for the Q&A session?

[Operator Instructions] Your first question comes from the line of David Kelley from Jefferies. Please go ahead.

Just a quick one on Transportation Solutions in autos. I guess if we look at your global vehicle production assumption for the full year, as you sit down 4 to 5, it seems like it’s in line where I think both - most are expecting given the recent downturn in China and maybe your September fiscal year-end. How should we think about the regional cadence, you're building into the back half of the year? And then I guess more importantly, the softer macro in anyway changed your customers' approach to electrification and connectivity and the related orders you're seeing there?

So, let's take it - I’ll start with the second piece and then I'll get into the regional if that's okay. Thanks for your question, David. First of all when it comes to electrification and autonomy or connected vehicle, I would tell you that nothing has changed. The amount of car rates that we have and it's one of the things we will balance to the softer environment to make sure we capitalize on those trends and you also see the benefit of those trends even in our first quarter, where our sales were down in a much worse production environment. And I think you're going to continue to see that content growth even in this weaker period where we outperformed production. Now when you think about your first part of your question, so let me go back a little bit and talk about auto. Clearly production is slower than we expected. When we started the year and we guided 90 days ago, we guided to what we thought was going to be a flat environment. We thought relatively flat in Asia, relatively flat in North America and slightly down in Europe. Clearly car sales in China were very weak in the first quarter, production adjusted in and we're also seeing production been adjusted here for the rest of the year. So, when we look at it, we do expect China production to be down 10% this year, European auto to be slightly worse than our prior guidance going to more mid-single digit down versus slightly down that we set the core, and North America staying where it is. Actually when you think about how we see that going throughout the year, we’re actually seeing and expecting from what we hear from our customers production is going to be more constant throughout the year than you normally would see. So with this week first quarter around 22 million units, we do expect that production is going to stay around 22 million units per quarter in our fiscal year plus or minus a little bit. So one thing I do want to stress and you mentioned in your comment anything we talk about auto production is on our fiscal year basis, which is very different than how others talk about which is more calendar basis.

Your next question comes from the line of Wamsi Mohan from Merrill Lynch. Please go ahead.

Terrence, really says that even in a 5% production decline environment, you're actually able to show auto revenues flat organically. Your fiscal 2019 guide obviously implies a 4 to 5 point like content growth over here. So can you just talk about what you're seeing within the pipeline that suggests that customers might not be mixing down or is this actually assuming that customers do mix down and that's why the content is 4% to 5%? And just to clarify, Heath can you just talk about the magnitude of that restructuring charge that you are taking and maybe which areas of the segment that will impact because you are already doing some restructuring on industrial and I'm assuming this was incremental to that, so if you could clarify that'd be helpful? Thank you.

Sure. Wamsi, thanks for the question and let me take the first half. Number one is let's go back to how we talk about content growth and how we’ve talked to you about and how do we think about it. And it has been in a 4% to 6% content range. And over the past couple of years, we've had a constructive production environment. You saw us actually overachieved that 4% to 6%over the past couple of years. And that also, you’ll see a little bit of supply chain effect, take that up in a growth environment. When we look at it, you're exactly right. We're still towards the lower end of our content range this year. There will be a little bit of supply chain effect, as well as lower value vehicles but that's included in our guide, and that's why you see it more towards the lower end of the content growth. I would say on a quarter-by-quarter basis, as supply chains adjust to a slower environment, you may see some separation that ounces around a little bit like we've always told you, but long term, the 4% to 6% and what we see the trends going and I think all of us who purchase new vehicles, you see the content around autonomy see, certainly the electric vehicle continues to pick up, no matter and it's also new product cycles and launches. And those launches typically happen later in our year, and due to product cycles don't typically hit early in our fiscal year, they typically hit later in the year and there, assume that our guidance as well. So with that, I’ll turn over to Heath.

Wamsi, it’s a good question on restructuring. As you mentioned, we had already had some assumptions in with our prior guidance and consistent with what we had talked publicly about over the last year and a half or so, which is some of the footprint consolidation opportunities within our industrial segment. We are broadening that as I mentioned in the opening comments, across portions of the rest of the other two segments, part of that is volume driven and part of it is taking advantage in this weaker revenue environment, opportunities to get after some things that we may not have been able to do, where capacity would have stood otherwise. So in addition to Industrial, it hasn’t broadened. And then the other thing to think about, we did sell the SubCom business and closed on that last quarter. And when you remove $700 million of revenue out of your P&L which is roughly what SubCom represented to the corporation, we do have some stranded costs in the middle of the P&L and operating expenses that you will expect us to tackle and we are going after those as well. In terms of quantifying it, we're still in the process of several of these initiatives. We're not in the point now, where I will want to dwell with the number but certainly as the quarter progresses and we get this call back together in about 90 days, we'll give you an update in terms of both the magnitude of charge over and above what we guided, and what you should expect from a savings profile from now.

Your next question comes from the line of Christopher Glynn from Oppenheimer. Please go ahead.

Just had a question about how much you think you've been able to ring fence or de-risk expectations here. Does it feel like kind of stable at a weaker run rate or market is still kind of searching for what the lower levels might look like?

No. Chris, I would tell you, you know order rates are staying right around this one book-to-bill. So, I would say other than China which was meaningfully weaker in our first quarter, it does feel, it's stable at a lower rate. And if you think about our guide change, we needed to step up and we sort of expected orders to stay around that $3.5 billion in our first quarter, and a little bit softer than due to China. So, we're looking at our order rate even in early January, does feel stable at a lower rate. Certainly, we're continuing to watch it. And we need to focus on clearly what we can control that Heath talk about. So, and it's very - it is mixed, you see only orders, our industrial orders were up 6%, and we see very good strength in aerospace, in the medical. We also continue to see broadly, very strong growth in the United States. So, there are mixed views between different angles you look at it. But China was weak across the Board and the adjustment is primarily due to China that we're adjusting to.

Your next question comes from the line of Craig Hettenbach from Morgan Stanley. Please go ahead.

Terrence, just a question on the broad-based weakness in China which has been evident kind of through the supply chain. But just you have end markets which are clearly slowing, but there's also likely inventory management happening. So any additional color you can shed on that in terms of your discussions with the customers and distributors as to how they're managing the weaker demand environment, and where you think they are at this point from an inventory perspective?

Well, in China, as I said on the call, our orders were down 22% and auto was weak, due to the weaker decline. And we’re planning the supply chain, you're always going to have some supply chain adjustment that's happening as people relook at their production to their end customer. So, whether that’d be a car buyer or an appliance buyer, anything else that is happening and so, we are going to work through as they do it and that as the supply chain element to it. Typically, they last three months to six months. So, depending upon the market, I would say we’re sort of in the early innings of that is what we're going through. I would say that is not consistent globally in places we have a healthy environment like in industrial, like in North America. I would say we see pretty healthy demand orders. We don't see contractions, but certainly in China we are seeing some contraction as people it's just normal behavior.

Your next question comes from the line of David Leiker from Robert W. Baird. Please go ahead.

This is Joe Vruwink for David. When I think about your orders in Asia since the middle of last calendar year, it's kind of gone from rising high-single digits to now down pretty heavily. And since the middle of last year obviously there's been escalating trade tensions and China's underlying economy has slowed. Have you given some thought, if we get maybe trade resolution or China explores a more aggressive fiscal stimulus, not just monetary stimulus, how quickly your business in Asia could potentially come back?

That a question that's probably beyond me. So when we look at it, clearly there's a lot of moving parts in the world, we would like all the moving parts, because we're global free traders, might we able to give everybody confidence. But when we look at it, we do not have stimulus in our guidance, is the way they should be thinking about it. And we would like constructive resolution to those matters but we've got to plan to what's in front of us and the environment we're seeing and that's what we’re doing.

Your next question comes from the line Shawn Harrison from Longbow Research.

A question I guess specifically for Heath on capital return and buyback. So buying back was greater than - buyback was greater and all in the first quarter. I think that was mainly the tough comp proceeds. But you guys are, one could argue, under-levered right here, if this is going to be the bottom over the next couple quarters for your business, do you get more aggressive with the buyback in the year and is there a number to think about, and is it – is that in the guidance?

What's assumed in our guidance - first of all, Shawn, thanks for the question. You're correct. We’ve returned $645 million in the quarterly, roughly $500 million of that was the buyback. And this proportion, remember that $500 million did come from the SubCom proceeds, which was about $300 million. So we obviously put that to work in terms of getting that back to the shareholders as we had committed to when we announced that transaction. As you think about the year in terms of the buyback, we generally say about a third of our free cash flow goes towards the buyback. So let's assume that's about $600 million, you can layer in on top of that, the SubCom amount and that gives you up to about the $900 million number. I think that's probably a fair way to frame that out. Now, in terms of, we are always looking at opportunities to intelligently deploy capital, that's not suggesting that we're going to do anything in terms of additional leverage, but we will flex from time to time in terms of where our capital is deployed and at times, when we look at the stock price relative to with the intrinsic of value of our company based on our strong free cash flows, that dislocation does create opportunity from time to time and we will flex a bit higher as it makes sense. So we'll keep you posted, but I'd say from a modeling perspective, you can use kind of the normal one-third plus the SubCom proceeds.

Your next question comes from the line of Mark Delaney from Goldman Sachs. Please go ahead.

Thanks for taking the question which is on data and devices segment, which I noted quite well this quarter and I think it is benefiting from data center. So if you can help us understand how much of data and devices is now tied to a particular data center? And it seems like in a go forward view of data and devices that there's maybe some weakness that's coming up in Asia for data and devices, if I read your slides correctly. So can you talk about what may be weighing on some of the incremental view in data and devices for the balance of the year. Thank you.

Mark, it’s Terrence, thanks for the question. First off if you’d like we think about data and devices and a lot of the repositioning we've done at that unit it was really around making sure that unit has pointed to high speed. Certainly the hyperscale which is broadly when you think about that entire high speed market is very lever to Asia you know the whole supply chain certainly some of how the ODM elements tie into it. But we look at hyperscale we do expect hyperscale to continue to grow nicely. We do see their capital being down slightly not down in dollars but the growth rate declining a little bit over last year. And the other thing that we saw was during the quarter - later in the quarter due to how much of that supply chain around it, that we did see orders around that supply chain get conservative. So I do think the positioning of the business is very strong. Certainly we're experiencing the broader Asia weakness is touching that like our other businesses. And what I would say it’s more around what we're seeing in Asia which is well above 70% of the revenue in that segment - well above 50% sorry, the revenue in that segment is tied to Asia. So it is something that we're being caught up with some of the other weakness we are seeing in that region.

Your next question comes from the line of Joe Giordano from Cowen. Please go ahead.

Quick one for me. So just first in, in terms of China auto I'm just curious is to how like orderly that 15% decline has been and I know the landscape there are very different than U.S. and Europe with a lot of OEM. So are you seeing like some trying to be opportunistic and take share from others during this kind of environment. And then I guess this - the second part of the question kind of spread more to communications too. But as we recover ultimately from some of these declines, do you think there's a fundamental change in the competitive position of non-Chinese companies and in those markets and as these markets start to grow again, will they gravitate more and more towards local producers of content than our Chinese own?

Well, let me start with the automotive piece. Certainly, when you take our position in automotive and the share we have in automotive, no different than we did in our last week period we had. We gained share and while we will adjust our cost base. One of the other things that's very important is that we're also very much focused on winning at the same time and when you think about our coverage in China, where we cover the entire landscape of the 50 OEMs that are in China through broad technologies. We will focus on gaining shares. So, I don't see some of the adjustments we're making impact and share there are actually very much discussions around how we gain share in these market environments, when other competitors typically scale back. In the data and devices side, certainly there’s an element which goes support China and then parts that support the globe. I don't think the competitive dynamic will change and what supports the globe certainly there is a piece that is very much around China OEMs. I think we just have to continue to watch with some of the dynamics to the earlier question. But right now when we think about the technologies we bring as long as our key competitors in that space. I think we have a significant advantage in the high-speed area over local companies and we will continue to invest in that innovation to keep that competitive low well and trenched going forward.

Your next question comes from the line of Steven Fox from Cross Research. Please go ahead.

My one question is on inventories. It looks like you guys built some inventories during the quarter even in the face of some of these declines. Can you sort of talk about your strategy going forward for your own balance sheet and how much it helped to hurt this recent quarter and then whether you’re seeing any unusual inventory activity in this project? Thanks.

Steven, given the severity of the slowdown particularly in the areas we've already talked about the call across China and parts of Europe in the back half of the quarter certainly, we did see some pressure on driving inventory up. Fortunately, that has in our model that comes out pretty quickly in terms of our ability to reduce inventory as we both correct our expectations both from a cost structure side as well as our revenue expectations around what's needed. So, in terms of anything that's systemic there's nothing there and you should see amatory levels come down fairly significantly between now and the end of the year. There are a couple instances where we do have facility consolidations that we have talked pretty openly about within our industrial segment and in a few other places. And that does as we're in the middle of any type of facility consolidation activity that does tend for over a short period of time drive inventory a little bit higher in those cases where you're producing buffer in order to handle the transition into new locations. So we have a little bit of that going on as well and that will continue sporadically during the year you'll see little bumps in terms of that. But otherwise nothing other than just the slowdown that drove some of that.

Your next question comes from the line of Amit Daryanani from RBC Capital Markets. Please go ahead.

I guess, just a question on your operating margin guide, the implied guide, I guess. If my math’s right, you guys are basically seeing operating margins go up by 50 basis points to 80 basis points in the back half versus the first half. Could you just touch on what is going to enable that? And I get you don’t want to quantify your cost reduction initiative but historically I think you’re cost reductions have taken 12 months or higher to pay back. I'm assuming that's not a lever for back half but I’m just curious what enables this margin expansion in H2 versus the front half of the year?

Amit this is Heath. I think as we think about the first half to second half, you've got a couple of things going on. We do have a little bit of normal seasonality in terms of first half to second half revenue and that has natural leverage that comes with it. That's not a huge number relative to maybe we've seen in the prior years, but there's a little bit of seasonality embedded in our revenue guidance, and that does have an upward impact on the margins. The very pointedly we've had restructuring activities going on. Some of the things that we do benefit from particularly as we get towards the end of our fiscal year, are some of the activities that we've been undertaking in our industrial segment, as well as some of the things that we're going after non-facility-wise rather operating expenditure’s relative to some restrained costs for the SubCom divestiture. So there are some are structuring activities that certainly benefit us in the back half of the year. You are correct, some of the newer things that we're running now tackle don't have the – you don't get as much near-term help on that, but that will certainly set us up very well for the next several years.

Your next question comes from the line of Deepa Raghavan from Wells Fargo. Please go ahead.

A follow-up on the margin question here, especially margin protection in the downside. It looks like there will be more cost cuts which is good but in the mean, does the guidance still assume auto margins will hit the 20% in second half, especially given that there was this mixed auto sense of a participation in Q1? And just longer term, will the SG&A and Industrial sales have helped margin ramp still be on track or will that be pushed out a little bit? Thank you.

Deepa, I think your question is a good one. In terms of our Transportation, we're running at about 18% here for the last couple of quarters and certainly that's below our target margin for that segment, which has a disproportionate impact on the overall margins for the company, given its relative size. As you think about our Transportation business, the way I would think about it is, you'll see the margins begin to improve sequentially as we move through the year. And much of that is driven by some cost actions that you'll see that are under way right now. And as those prevail in terms of our end of the year exit rate, you'll be closer back towards that 20% number that historically has been our target for that Transportation segment. In terms of the Industrial segment, that is really relatively unchanged. When we talked about 90 days ago on our call was that, this year, you won't -- we've seen significant step up in our Industrial segment margins over the last two years. And as you work your way through these footprints, consolidation activities and these are fairly sizable things that are underway right now within that segment. You should expect that the margins are going to stay relatively flat, maybe modestly higher as we go through this year within Industrial, but you'll see another step function improvement as we go into the next several years, as these facilities come off line. So not a lot has changed on the Industrial side relative to margins in our expectations. Certainly, we would see a recovery towards the end of the year within Transportation.

Your next question comes from the line of William Stein from SunTrust. Please go ahead.

I believe the weakness in China generally and automotive as well is pretty well understood that’s I don't think surprising anyone, what’s a bit of a surprise was that the guidance for industrial at least for the March quarter looks a little bit better than what I was expecting and I think you're reiterating for the full fiscal year. Can you dig into what's triggering that that sort of guidance relative to the current environment is that all aerospace defense or these new programs, content wins, new technology, greater volumes, any clarity would be helpful? Thank you.

Couple of things, first, let me just frame our industrial segment wallet it, it does have a China position, it's not as weighted to China and Asia as our other businesses, it is - it has a heavier weighting more to Europe and North America. So I do think that that’s part of it versus the other trends. Also it is the mix that you should indicated, and I'll go back to if you look at our orders on the earlier slide I mentioned, our book-to-bill in industrial was above 1, I think it's around 1 of 7. So it is having very good order trends and it goes back to the markets we talked about. It does go back to we're seeing a very strong commercial aerospace, we're seeing - also seeing very strong defense market that is pretty broad in our aerospace and defense unit, we also continually see the benefit of our investments in medical that where you look at while our industrial equipment which includes medical is down slightly. Our medical business is offsetting what we talked you about even probably about nine months ago that we expected factory automation to get a little slower because of wells running well above trend line. So, when we look at industrial it really has not changed. And honestly from an orders perspective you know was the one segment in the first quarter where orders came in where we expected for the year and working continuing to see good order momentum and industrial around those key markets I talked about.

Your next question comes from the line of Jim Suva from Citi. Please go ahead.

In your prepared comments, one of you made the comment about as you exit the year you expect to be stronger. Was that in reference to operating margins each and every segment, the company in totality or earnings per share or how should we think about what that was referring to?

Jim, I made that comment. And that is you know a total company comment. Certainly, we have levers that are different by our segments. And when we made that comment that was truly made had a view point of earnings per share and at a total company level. And certainly as he talked about, we do expect operating margin to improve I think we did a good job highlighting the levers, but certainly our earnings power, we also viewed, we're going to continue to improve as we exit the second half versus when you compare year-on-year.

Your next question comes from the line of Matt Sheerin from Stifel. Please go ahead.

Just another question regarding your auto guide. I know you're guiding you are sort of in between North America and in Asia down modestly. We should though I think have some improving year-over-year comps as we get through the year particularly given the WLTP testing that went on in Europe and slowed things down. So what's your perspective on that market relative to production, but also relative to the relationship between Europe and exporting into Asia?

Well, a couple of things. When you think about it that you're right some of our incremental decline is around. WLTP has been lingering and we also have certain customers really get extended shutdowns that went into January. So we did see a weaker European environment due to WLTP and certainly shutdowns there. And just the overall tone around Europe whether it's Brexit, whether it's WLTP, whether it's cars going from Europe or Asia, it is sort of reflected in our outlook. But what I would tell you we are sort of seeing probably off the point we were in the fourth quarter, you'll see you're sort of more normal your shape which is typically auto production in our third fiscal quarter takes off and then sort of gets in a little bit slower in the fourth quarter due to just traditional production bill schedules. But we are still expecting Europe to be down mid-single-digits with the bulk of that happening in the first three quarters of our fiscal year.

Your next question comes from the line of Christopher Glynn from Oppenheimer. Please go ahead.

Just a couple on cash flow dynamics, sorry if I missed that, but curious on the CapEx outlook and then for working capital given the organic outlook would you expect working capital would be a source of cash this year?

Let's take CapEx first. So our CapEx as we guided last quarter was expected to be in the range of around $850 million for the year. We'll bring that down some as we've seen certain activities slow down. But you got to know that the vast majority of our CapEx fortunately is tied to customer programs. And we win a customer program and that's not just within auto or commercial transportation, that's really across the board. When we win a customer a program that generally commit us to some level of tooling and fit-up in advance of production. So given the long-term horizon and the strength of that, we're still committed to because that's been - because that has the best return on capital, just about any other opportunities out - that's out there. So you should expect it somewhere in that $800 million, $850 million, will prune if necessary. The other point is exactly right on target though. Working capital won't be a source of cash this year. Particularly as I mentioned earlier on inventory, receivables will have a natural impact coming down with the sales and payables. We’ve a robust program to drive payables improvement, we're pretty good at that already. But you'll see inventory correct as well as part of - the needs to bring that down. So we would expect that as we make our way through the next three quarters towards the end of our fiscal year that will continue to be a source of capital.

Your next question comes from the line of Mark Delaney from Goldman Sachs. Please go ahead.

Thanks for taking the follow-up question. About aerospace and defense, which I know did quite well this quarter, but given the U.S. government shutdown, just curious if there's been any change in the overall operating environment in terms of ability to win new programs or order rates or things of that nature? Thank you.

No. Good question, really. How we do design and we're actually with the times and so forth. So that's really not having an impact on us just due to where we are and how we do our design work with the primes in that space.

Your next question comes from the line of Amit Daryanani from RBC Capital Markets. Please go ahead.

Thanks for the follow-up guys. Heath, I was hoping you could talk a little bit more on the sensors side sort of what do you think the growth trends or growth trajectory looks like in fiscal 2019 and then on the margin side is there a way to think about what sort of headwind with the sensor business to transportation margins in fiscal 2018 and how does that diminish I guess in 2019.

A couple of things on the latter part, it's pretty small due to the weighting of the total segment Amit. So I won't over focus on that. On your point around the pipeline what we really like about this year sensor business is - you sort of saw the growth rate go down a little bit and it is being impacted by the global macro because there is a big piece of it that those go into industrial transportation, those go into industrial applications today. But as we go through the year you're going to see some of the auto wins that we’ve had as those launches happen later in the year, helped the growth rate sensors. So we are getting the benefit of those there as we told you. They were later in 2019 events just due to have auto production hits and those launches hits, so you'll continue to see more positives on the auto side than the sensors as we go through the year and where we are today.

Your next question comes from the line of Deepa Raghavan from Wells Fargo. Please go ahead.

Thanks for the follow-up. Two quick housekeeping questions, what's the updated tax rate assumption, it looks like the lower headwind is more than just of the Q1 event and to what's the embedded free cash flow conversion rate within the guidance. Thank you.

Deepa, as I noted in the prepared comments, the expected effective tax rate for the year is between 18% and 19%. So we did drop out modestly from our original guide, which was closer to the 19% level. As you would expect, given the complexity of our structure, you're going to have some quarters to swing around, particularly when you have statute explorations that hit us at different points in the year. In terms of the cash conversion, I think you could still model it or it'll be up in that 80% to 90% range as we work through. We've increased our CapEx over the last two years as you can see in the numbers and there's still take - there’s a little bit of lag for the depreciation to catch up on that in terms of how that math works, but it will be up in the higher end range would be our assumption for the year in terms of free cash.

Your next question comes from the line of Steven Fox from Cross Research. Please go ahead.

Not really a question, just a quick clarification. Your new guidance, does it assume more cost savings relative to your prior plan or is that more like fiscal 2020 help? Thanks.

Steven, there is some incremental restructuring that we will benefit from in the back half of this year, certainly relative to our original guidance and that's one of the reasons we're able to withstand on the lower revenue growth, a pretty low flow through down to our revised EPS, is largely tied to our ability to get cost out of the business. Now having said that, there will be - part of what Terrence and I have had mentioned earlier in this call, we are taking advantage of the slower environments to much more aggressively go after the fixed cost structure of the business and that will enable us to have a step function improvement in terms of overall profitability in the out years. So, we’re focused both on preserving income and cash flow for this year, as well as what it sets ourselves up for to drive profitable business going forward.

Your next question comes from the line of William Stein from SunTrust. Please go ahead.

Thanks for taking the follow-up. You talked about customer uncertainty relative to all the geopolitical risks that we're aware of, when you look at your customer orders or when you have discussions with customers, I'm sure it's different for many of them across the spectrum but what would you estimate is their assumption as to the resolution of the current sort of trade negotiations going on. We're asked another way, if we see tariffs tick up from the 10% rate to 25%, do you think that's already contemplated in your customers outlook or is that incremental to demand? Thank you.

Well you know how many customers we have, it’s basically well over 0.5 million. So to sympathize that it's very different pending about where they are in the world, as well as other opinions they have. So I really can't answer that. I think everybody has been planning and working around a tariff environment and I do think that creates uncertainty for all of us, so people go to the conservative side versus the aggressive side, and that's really the only color I can give you from our customer discussions.

Okay. Thank you, Will. It looks like there is no further questions. So if you have additional questions, please contact Investor Relations at TE. Thank you for joining us this morning. And have a nice day.

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