TE Connectivity Ltd. (TEL) Q4 2020 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by and welcome to the TE Connectivity Fourth Quarter Earnings Conference Call for the Full Year 2020. At this time, all lines are in a listen-only mode. Later, we will conduct a question-and-answer session. [Operator Instructions]. As a reminder, today's call is being recorded. I would now like to turn the conference over to our host, Vice President of Investor Relations, Sujal Shah. Please go ahead.

Good morning and thank you for joining our conference call to discuss TE Connectivity's fourth quarter and full year 2020 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 Web site at te.com. Due to the large number of participants on the Q&A portion of today's call, we're asking everyone to limit themselves to one question to make sure we can give everyone an opportunity to ask questions during the allotted time. We are 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 results of the fourth quarter as well as our expectations for our first quarter fiscal 2021. Before I get into the slides, I do want to frame out some key points about today’s call. First off, I am very pleased with our execution in the fourth quarter where we delivered sequential sales growth of 28%, which was above our expectations and adjusted earnings per share of $1.16. Our top line benefitted from a better-than-expected recovery in automotive production, coupled with our leading position in this market. Adjusted operating margins expanded sequentially by over 500 basis points while we also executed on our inventory reduction plans that we discussed with you last quarter. And while we’re still in a market where we’re being impacted by COVID-related weakness and it has challenged our business model, our margins and EPS, I also believe we successfully executed on a number of the key elements of our business model, including strong free cash flow as well as content growth that helped offset the weakness we had in key markets. And I’ll come back to this in a moment and get into a little bit more detail under that. The other thing is that we are pleased to see a faster recovery in certain markets as evidenced in our orders, but I do want to highlight that the visibility on the shape and the slope of the longer term recovery still remains limited. And lastly, as we look into our first quarter, we are expected sales to be roughly flat for the first quarter of fiscal 2021 but with adjusted operating margin and earnings per share expansion both year-over-year and on a sequential basis. And for the first quarter, which Heath and I will talk about, we are expecting sales and adjusted earnings per share of approximately $3.2 billion and $1.25, respectively. While the challenges that we've experienced associated with COVID impacted the second half of our year, I am pleased that we just demonstrated the key elements of our business model in fiscal 2020. We are benefiting from the active management of our portfolio over the years, and the actions that we've taken to optimize our cost structure. And before we get in the slides, again, I just want to give a few examples of what stood out for us during the year. First off, despite the market headwinds, we benefitted from the secular trends across the business that we've positioned the company around. And this is evident in automotive, where we delivered 6 points of growth versus the auto market in 2020, which reinforce our ability to generate content growth in both a growing and declining production environment. And it's also important to remember that China is the largest auto production market in the world. And we've benefited from increased volumes and our leading position in this region as its recovered. Another highlight is our communication segment that remained resilient through the downturn and delivered strong growth both year-over-year and sequentially in the second half, driven by the build out of data center capability. We also saw margin expansion with the segment delivering adjusted operating margins at its mid-teens target level for the year. And lastly, the foundation of our business model is the cash generative nature of our businesses. We once again demonstrated this in fiscal '20 with $1.5 billion of free cash flow and this represents 104% conversion in net income. With this as a backdrop, I do want to take a moment to provide some perspective on our business and markets relative to our last earnings call 90 days ago. Last quarter, we said that the third quarter would be the low point of the downturn. This is now confirmed with 40% improvement in sequential orders in the fourth quarter, along with sequential revenue and EPS growth both in the fourth quarter as well as what we expect into the first quarter. As we look into the first quarter, the business is returning to prior year levels, with expansion of adjusted margin and earnings per share. And while auto production has come back a little bit stronger than we expected, we are still well below 2019 production levels of 88 million units on an annual basis. And we still believe the shape of the recovery will continue to be gradual and dependent on the global consumer. Over 19 million vehicles were produced in the fourth quarter and we expect sequential improvement in auto production in the first quarter to 21 million units. In our other two segments, the industrial and communication segments, we do expect them to be down sequentially, with some pockets of weakness like we have in commercial aerospace. So with that, let me get in the slides and if you could please turn to Slide 3, I'll provide some additional details for the fourth quarter and the full year as well as our expectations for 2021 first quarter. Quarter four sales of $3.26 billion were better than our expectations and up 28% sequentially. Transportation sales were up approximately 50% sequentially driven by the recovery in our auto sales, which were up 68%. Industrial sales were up 11% sequentially with growth across all businesses. And in our communication segment, sales were up slightly sequentially, and up 12% year-over-year. During the quarter, we saw orders of approximately 3.35 billion and a book to bill ratio of 1.03, which I'll add more color on when I talk to that slide in a moment. Adjusted earnings per share was $1.16 and adjusted operating margins were up 500 basis points sequentially to 14.5%. As we mentioned at the onset of COVID, we kept inventory levels relatively high to ensure we could meet commitments to our customers through a period of supply chain volatility. During the quarter, we drove a significant reduction in inventory in TE, primarily in the transportation segment with some reduction in industrial as well. This helped our free cash flow but did impact our margins negatively both at the company level and in the transportation segment. In the fourth quarter, free cash flow was approximately $650 million and we returned $1.1 billion to shareholders during the year, including approximately $625 million from dividends and $500 million through share buybacks. When we look to the full year 2020, sales were $12.2 billion and they were down 10% year-over-year on both a reported and organic basis due to the impacts of COVID on our markets. Adjusted operating margins were 14.2% with adjusted EPS of $4.26. While transportation and industrial were impacted by the market weakness, our communication segment grew 15% organically from the first half to the second half, demonstrating the diversity of our portfolio. I am also pleased that we didn't hit this downturn flatfooted. Prior to the onset of COVID, we began executing on cost reduction and footprint consolidation plans in the transportation and industrial segments to get to the target margins we've been discussing with you. As we look forward, we do expect quarter one sales of $3.2 billion, which is up 1% year-over-year on a reported basis and adjusted earnings per share of $1.25, up 3% year-over-year, which is an expansion in both adjusted operating margins and EPS in the first quarter. So if you could, I would appreciate you turn to Slide 4 and let me talk about orders across the businesses as well as geographically. For the fourth quarter, our orders were over $3.3 billion and our book to bill improved to 1.03, as I mentioned earlier. On a year-over-year basis, transportation orders grew 12% driven by auto, but we did also see growth in our commercial transportation and sensors orders as well. Industrial declines year-over-year were primarily driven by the ongoing weakness in commercial aerospace and in communications, our growth was 13% driven by the appliances business unit as that market recovers globally post-COVID. Our book to bill was above 1 in transportation and below 1 in our other segments, supporting our sequential revenue growth in quarter one in our transportation segment and the declines we expect sequentially in industrial and communications. So let me add some color on orders from a geographic perspective. For the second consecutive quarter, we saw an increase of orders in China, which were up nearly 25% year-over-year in the fourth quarter with growth in each of our segments, but particularly strength in transportation. We saw approximately 8% year-over-year growth in our orders in Europe, and this was also primarily driven by transportation. And in North America, our orders declined 8% year-over-year, primarily driven by the industrial segment and weakness in the Comm Air market. So with that as a backdrop of orders, let me get into the segment results and that will be on slides 5 through 7, then I'll hit the high points that will be on the slides as I go through the segments. So let me start with transportation. Transportation sales were down 6% organically year-over-year, with declines in each of our business as you can see on the slide. In auto, sales were down 4% organically driven by global auto production declines. Even with the dynamic changes in the auto market due to COVID in 2020, we generated 6 points of content growth for the full year. And that just proves our continued outperformance versus the weaker market. I would ask you to keep in mind that content growth can vary quarter-by-quarter, but we continue to expect 4% to 6% content growth in auto over the long term. And when you look at 2020, the production of internal combustion vehicles dropped nearly 20% this year. But we did benefit from the increase in hybrid and electric vehicle production that was up 13% in our fiscal year. When you look at hybrid and electric vehicle production, that represents 10% of total global auto production and we expect that EV and ATV production to reach approximately 20 million units in the next five years. Our customers' plans remain on track for full battery electric and hybrid electric vehicles. And there's even been some acceleration of roadmaps as OEMs respond to increase demand and a more stringent regulatory environment in certain parts of the world. We are a leading provider of technology and products to our customers as they move to more sustainable hybrid and electric platforms. In sensors, we sold 10% growth year-on-year due to the revenue contribution from the First Sensor acquisition. And on an organic basis, sales increased 9% sequentially as we expected, with our year-over-year performance being impacted by the market volatility. We continue to grow our design win pipeline and auto applications and expect growth as these platforms increase in volume. Adjusted operating margins for the transportation segment declined year-over-year as a result of the planned inventory work down in the quarter that I mentioned earlier. We expect significant sequential adjusted margin expansion in the transportation segment in the first quarter, which will be the driver of the company's margin expansion both sequentially and year-over-year in the first quarter. Let me turn to the industrial segment. In this segment, sales declined 6% organically year-over-year and our adjusted operating margins were approximately 14% and impacted by the lower volumes as well as some of the inventory work down. We remain on track with our long-term margin expansion plans in this segment and we remain focused driving adjusted operating margins into the high teens. During the quarter, the segment continued to be impacted by the decline in the commercial aerospace market, with our aerospace defense and marine business declining 13% organically. We do expect the common [ph] weakness to continue into early '21, as the market is still in the process of bottoming. In our industrial equipment business, our revenue was down 2% organically and better than we expected with declines in Europe being partially offset by growth in Asia. We continue to see weakness in our medical business with ongoing delays in elective procedures caused by COVID. We believe this is a short-term dynamic in our medical business as consistent with what our customers are saying, and we expect this market to return to strong growth as elective procedures start to increase. Turning now to communications. Our sales grew 11% organically year-over-year, with growth in both data and devices as well as appliances. We continue to benefit from the recovery in China and Asia more broadly, which represents over half of our sales in this segment. Data and devices grew 7% organically year-over-year due to our strong position that we built in high-speed solutions in cloud applications. Appliances grew 18% organically year-over-year with growth across all regions and benefits from an improved housing market, as well as supply chain replenishment. Our communications team performed very well and adjusted operating margins grew to over 21% in the fourth quarter. This strong performance is a result of the multiyear transformation of our portfolio and reduction in our cost structure and manufacturing footprint. Adjusted operating margins for the segment for the full year were 16% which is in line with our target. And we continue to expect mid-teens operating margins long term in this segment. So with this overview of segment performance, let turn it over to Heath who'll get into more details on the financials as well as our quarter one expectations.

Thank you, Terrence, and good morning, everyone. Please turn to Slide 8, where I will provide more details on the Q4 financials. Adjusted operating income was 473 million with an adjusted operating margin of 14.5%. GAAP operating income was 347 million and included 113 million of restructuring and other charges and 13 million of acquisition-related charges. For the full year, restructuring charges were 257 million. And I expect restructuring charges are approximately 200 million in fiscal '21, as we continue to optimize our manufacturing footprint and improve the cost structure of the organization. Adjusted EPS was $1.16 and GAAP EPS was $0.69 for the quarter and included a non-cash tax related charge of $0.17 related to an increase of the valuation allowance for certain deferred tax assets. We also have restructuring acquisition and other charges of $0.31. The adjusted effective tax rate in Q4 and the full year was approximately 17% and for FY '21, we expect an adjusted effective tax rate around 19%, but it’s important to note here that our cash tax rate will still be well below that in the mid teens. Turning to Slide 9. Sales of 3.3 billion were down 1% on a reported basis and down 4% on an organic basis year-over-year. Currency exchange rates positively impacted sales by 39 million versus the prior year. And at current levels, currency will be a 55 million tailwind in Q1. Adjusted operating margins were 14.5% and expanded 510 basis points sequentially, as mentioned earlier. While we anticipated pressure to our operating margin performance due to the planned inventory reduction we highlight last quarter, I am pleased that we reduced inventory by nearly 300 million in the quarter. So just as a point of reference, our inventory overall came down 12% from the June quarter to the September quarter. As you can imagine, that had a couple hundred basis points of pressure to our margins as we got the inventory right-sized, but I feel good about the impact it had on our cash flows. The inventory reduction primarily impacted the transportation segment. We also had some impact in the industrial segment. We continue to execute on our footprint of consolidation plans and pursue additional opportunities to drive cost reduction. We remain committed to our business model margin expansion goals and we expect volume growth combined with our restructuring plans over time to drive adjusted operating margins and transportation to 20%, industrial to the high teens and communications consistently in the mid teens. For the quarter, cash from continuing operating activities was 719 million. Free cash flow was approximately 650 million for the quarter. For the full year, free cash flow was approximately 1.5 billion which represents 104% cash conversion. For fiscal '21, we expect free cash flow conversion to again be strong at approximately 100%. Looking back on our performance in fiscal '20 and the extreme volatility we saw in our in-markets, our cash flow and capital structure performed in line with our expectations. We maintained a strong liquidity position and generated strong free cash flow in each quarter of this year. We maintained a balanced capital strategy, returning capital to shareholders and remaining active in M&A with the acquisition of First Sensor. During the year, we spent 505 million on share repurchases buying back 6.5 million shares. At the same time, we continue to invest for future growth through R&D and capital spending initiatives and we're able to gain share with key customers through our robustness we showed in our manufacturing operations. Going forward, we remain committed to our balanced capital deployment strategy and expect to return two-thirds of free cash flow to shareholders while supporting our inorganic growth initiatives. Please turn to Slide 10 to discuss our expectations going forward. For Q1, we are expecting sales of approximately 3.2 billion, up 1% on a reported basis and down 2% organically on a year-over-year basis. Sequentially, we are expecting organic growth in transportation to be offset by modest declines in both industrial and communications. On a year-on-year basis for the first quarter, we expect transportation to be essentially flat organically; communications to grow mid-single digits and industrial will be down mid to high-single digits. Adjusted EPS is expected to be approximately $1.25, up 3% year-over-year. And for the first quarter, we are expecting significant growth in adjusted operating margins from the fourth quarter levels. As Terrence mentioned, we are still dealing with low visibility and it’s difficult to predict the shape and slope of the recovery in different end markets and geographies as the world continues to deal with COVID. We do want to share some of our key market assumptions as we plan the business. We expect global auto production to be approximately 21 million units in the first quarter, up sequentially from Q4, but still below prior year levels. Due to the December quarter being the strongest production level of the year in China, we are expecting Q1 to be the high point of global auto production for our fiscal year. We continue to expect strong content growth of 4% to 6%, enabling us to continue outperforming the auto market. In industrial, we continue to expect commercial aerospace market to stay weak, declining over 20% for the second consecutive year, but we do expect our medical business to improve as we move through the year. In communications, we expect continued increases in cloud provider spending, driven by the growth in online activities and our data and device business plays directly into this favorable trend. So I've already summarized some of our financial assumptions for the fiscal year on this slide. They are there for easy reference for you. Now, let's open it up for questions.

[Operator Instructions]. Your first question is coming from Wamsi Mohan with Bank of America.

Thank you. And congrats on a really strong quarter and guiding in this environment. Heath, I was wondering if you could clarify some of the moving pieces on transport margins. Your transport revenues were almost flat on a year-on-year basis, but you had big negative leverage. How much of that was the inventory issue that you were addressing earlier? And can you clarify what the inventory levels are now and if there's going to be any residual impact to margins in fiscal 1Q? And just as a point of clarification on the comment on reaching the high point of production in the December quarter, I don't think you're suggesting that also implies peak EPS in fiscal 1Q, but was just hoping you would clarify that as well. Thank you.

Thanks, Wamsi. And let me try to tackle those here. Certainly that inventory reduction, more than two-thirds of it or so from the total was in transportation, and that was really the driver of our transportation margins being close to the 13% level. So we would expect as we move forward, inventory is now in the right place in terms of what we need to see moving forward and I would expect the Q1 numbers to tick up significantly at the transportation level. And as Terrence noted earlier, that will flow through nicely to the overall performance for margins in our first quarter. In terms of the comments around Q1, we're trying to highlight that the 21 million vehicle auto production number in Q1, we anticipate that 21 million to be the high point in the year. That does not mean that that's going to be necessarily the high point of TE’s revenue or EPS for the year, okay, and we've got other businesses in the portfolio and some do have some seasonality element to it, in addition to some of the medical recovery that we would anticipate more in the second half of our fiscal year. And obviously, we're actively engaged in a lot of cost reductions. We've got pretty significant heavy lifting this year with some plants coming offline. The timing of those will be staggered throughout the year. But as you can imagine, as the year progresses, certainly we start to benefit more and more from exiting those costs. So, hopefully, that clarifies your question.

That’s great. Thank you.

Thank you, Wamsi. Can we have the next question please?

The next question comes from the line of Amit Daryanani with Evercore.

Good morning, guys. Thanks for taking my question. I was hoping, Terrence, maybe you could talk a little bit about content growth and how do you see that stacking up in fiscal '21, especially on the EV market in a scenario where there are more tighter fuel efficiency and emission standard requirements, especially in the U.S., what could that do to the content growth number that you guys have in fiscal '21?

Yes, certainly. I think 2020 clearly solidified where we sort of said 4% to 6%. There is an element of where does the consumer go to buy as well as the government programs help them. One of the things that have been very nice and I mentioned in the comments is you see EV production and car sales really increase last year double digit in what's a really tough economy. And it was more in Europe and it actually was where it's been in Asia. And we still view that Asia and Europe will be the leading areas where you get adoption. Like we've always said is you do typically need – where EVs are still less penetrated, you do need some government help to basically make sure as that scales. And the U.S. is still an area that is less penetrated than the others and has less regulation. So anything that helps EV penetration and increased penetration helps our growth. And a chunk of our content is driven by the EV growth this past year being in the double digits. And we're bullish on EV and certainly we've been investing to make sure we have scaled that architecture globally. And what's nice is it looks like the bigger adoption is going to be in Europe and Asia which is our strongest market positions.

Great. Thank you, Amit. Can we have the next question please?

Your next question comes from the line of Mark Delaney with Goldman Sachs.

Hello, Mark. Are you on? All right, it looks like we’re having an issue. Could we go to the next question please? Then come back to Mark.

Your next question comes from the line of Craig Hettenbach with Morgan Stanley.

Thanks. A question for Terrence. If I look at your December quarter, it looks a bit above typical seasonality. I know this is a very unusual year in terms of what's played out up to date, but just curious to get your context in terms of what you're seeing for December versus what you typically see in any puts and takes by the end markets there?

Yes, let me spend a little time on that. And the first thing I would say is, and we’ve talked about it, so that we're all aligned, auto production typically in the December quarter is the strongest quarter of the year of global auto production. And that's really driven by China being the largest producing country in the planet. And as they've taken that position, the December quarter is typically the strongest in China. And that's why we believe the first quarter can be probably the strongest for the year. But as we look across the portfolio, you take areas like industrial and transportation, they are areas that have been hit hard by COVID. We did see sequential improvement. We did benefit from China strength, but our global position is also driving great content in places like India and Europe that we think can be a growth driver, as we go into next year, even though China may have some market anniversarying, it becomes a little bit tougher. In the industrial markets, Craig, Comm Air, we do expect we are in the middle of a bottoming process there. We do think that will be a little bit negative as we go into the early part of '21. But we do get excited that the medical business is going to be rebounding back here as elective procedures pick up. And in communications, we talked a lot about our performance this past year and I think we're going to continue to benefit from as our global appliance position that you saw the benefit in revenue as we go into next year, and that recovers and certainly rebounds as well as where we've done things secularly in our D&D business, which has been a lot of hard work, we reposition that. So I do think it's a little bit different than normal seasonality. Seasonality is tough to sort of think about in this environment when our customers are telling us visibility is short. But it's nice to see the recovery coming back a little bit faster than we thought in auto. And we're trying to stay close to our customers on how do we help them as we're all dealing with an environment where visibility is light.

Okay. Thank you, Craig. Can we have the next question please?

Your next question comes from the line of Shawn Harrison with Loop Capital.

Hi. Good morning, everyone, and my congrats on the strong finish for 2020. I wanted to just dig a little bit deeper in the margins on a twofold aspect. Number one, do you expect transportation EBIT margins to be back to the year ago levels [indiscernible] for the inventory that came out? And second, how do we think of kind of incremental margins either across transportation as well as industrial from here knowing that we've got a couple of years in restructuring in hand?

Thanks, Shawn. This is Heath. I think you can – as we look into FY '21, and obviously we're only guiding this first quarter, we feel pretty confident in our ability to get back to prior levels in terms of margins for transportation for sure. In terms of the incrementals, I think it's fair to say at the TE level that thinking about a 30% or 35% flow through is a fair way to think about it and that pretty much is consistent down through the segments. Now we used to say kind of 25% to 30%, if you recall, some of the activities that we've undertaken, are allowing us to step up some of our commentary a little bit. So I feel pretty good about that. Now keep in mind that some of the heavy lifting that we're doing on restructuring on at least some of these plants, if these plants were easy to take offline, we would have done it a long time ago. So they are in many cases from the time that we announced and taken charge, it can take 12 or 15 months to completely get them offline and exit the costs from those. So we're active. We've seen plants come offline in FY '20. And then in FY '21, we'll see another surge of that. So we're really probably talking FY '22 and so forth before you start to see the more significant step up incrementally from here. But certainly at the TE level, we expect margins to improve dramatically in our fiscal first quarter.

Thank you, Shawn. Can we have the next question please?

Your next question comes from the line of David Kelly with Jefferies.

Hi. Good morning, guys. I appreciate you taking my question. I just wanted to get a feel for some of the opportunities that are front in mind for TE under a new year with hopefully some continued grant towards normalcy. So, could you talk about some of the biggest strategy opportunities out there that you see on the horizon, things like whether it's ramping electrification in auto, returned to M&A, or broad electronification as a content driver?

Sure. Thanks, David. And let me take that. Now first off, it is nice to see the world still in recovery mode certainly with the uncertainty that's around due to COVID. But probably the first thing that we're excited about is not only how the portfolio is sort of playing out, like we expect it in a cycle, because we will be impacted by auto cycles due to our great position there, but I would also tell you that dealing with what we've dealt with 2020 that we do have a clean portfolio versus what we've had in other cycles I think came true. And honestly, it allows us to play offense around where we make our investments organically as well as if we do want to bring both [indiscernible]. And from that viewpoint, I think that's the number one thing that's nice going through the cycle versus others. I think we gave you some examples about the content. The number one content driver for TE is around automotive. It is around electrification. It's also the element of surround data in the car. And that's why we get excited with the 600 basis points we showed last year about performance. And we are confident that the wins we have that that type of level in our 4% to 6% that we've told you about above production as global production continues to heal. And let's face it we're so well off, the 19 plus million units of cars produced a few years ago. The other thing that I would tell you is, during this downturn, it's given us an opportunity in many ways to really make sure we get closer to our customers. They need to make sure they have the partners with them that are going to be there long term. And I do believe our manufacturing strategy that we've been investing in, which includes the cost actions that Heath talked about, has really been an element of how did we get and continue to move our over manufacturing to be local for local. And it's been a journey. We had a lot of work to do on that. It provides cost, but it also provides sort of a settlement. And it does come back to why we feel good that we can enter this flatfooted. We understand that we have margin opportunity in transportation and industrial. We've been talking about that. And how do we couple that with the content opportunities, not only in automotive but in medical, and also what we've done in cloud are things that we get really excited about, and we have the engineering wins that support that. So, as we're all dealing with an uncertain environment that we have to navigate through and adjust to, but we also have to accept the reality of the opportunities as well as we're – some markets like Comm Air, we have to adjust to the reality of that market won't be what it was. And they are the things that I think will drive both growth levers from here, but also margin levers. And our capital structure and free cash flow generation allows us to make sure we can be focused on improving the business and growing the business.

All right. Thank you, David. Can we have the next question please?

Your next question comes from the line of Deepa Raghavan with Wells Fargo Securities.

Hi. Good morning, all. Congrats on the solid execution as well. I have a margin question too. On Q1 year-on-year, how do you think about industrial margins in Q1? I'm assuming we won't see the inventory impact repeat in Q1. So would that grow margins here year-on-year in Q1? Also, your leverage in auto should be pretty nice in Q1, just given the auto production peak volumes, 21 million. But what kind of margin levers do you have post Q1, and should we expect that margins in TS can grow the rest of the year also? Clearly you've under earned because of COVID situation in 2021.

Thanks, Deepa. There's a lot packed into that question, so let me get at it. The industrial margins, I think the prudent viewpoint on that is that they'll kind of move – they'll be consistent in Q1 with what you saw in our fiscal fourth quarter that we just completed, albeit on lower revenue, which was expected and there is some seasonality as we move generally through the year within industrial. So I think we're holding our own there in terms of the journey within the industrial margin structure. But from a Q4 to Q1, I think you should expect those to be roughly flat on lower revenue. Obviously, your question around auto and then more broadly TS, the impact that it has, you are correct. We do have some good leverage there. In terms of our Q1 performance, I think we've talked about a few different times here on the call in terms of seeing significant sequential improvement in that. And then as we move throughout the year, the auto was obviously – we gained a benefit of the content and we've seen those. That activity continued to be strong. But it kind of gets down a little bit to what you think auto production is going to do in the subsequent quarters. That's one element of it. And then, obviously, as we layer in some of the restructuring activities, we have several plants that are becoming offline, but you'll see those more impacted late in FY '21 and more pointedly in FY '22. So there are some pieces there. But we feel very good about the actions we've taken to date and what that allows us to do on the incrementals moving forward. And again, we've kind of stepped up our dialogue there from, I'll say, pre-COVID activities in terms of what we think the incremental is going to look like.

Okay. Thank you, Deepa. Can we have the next question please?

Your next question comes is the line of Samik Chatterjee with JPMorgan.

Hi. Thanks for taking my question. I just wanted to hit the EV content story in a different way and see if I can get some more color here, particularly when you rated it today the 4% to 6% content growth in automotive as well as the 20% margin outlook longer term? Why shouldn't I be thinking of – as the EV content story kind of plays out, it may be upside pressure on both of those lockdown targets related to content outperformance or be it 20% margin if kind of what we're seeing in terms of roadmap acceleration on EVs does play out?

I think the key that you have is we do have to remember, we're on every [indiscernible]. And certainly when we think about the 4% to 6%, EV is probably 200 to 300 basis points of that. So when we look at that, when we think about it, it's across our whole portfolio. So we continue to see very strong growth in EV and high power products. But you also have to realize what percentage is of global auto production. So I think you will have yours and as the EV goes quicker in adoption, you would have us closer to the higher end of our 4% to 6% range. But certainly adoption will be important. The other thing I would just say to the margin element, like anything, EV products or things we have to scale and from that viewpoint, how they scale and how we get volume leverage is going to be very important of whether there would be margin upside potential to our target margins.

Great. Thank you.

Thank you.

Thank you, Samik. Can we have the next question please?

Your next question comes from the line of Mark Delaney with Goldman Sachs.

Good morning. Thanks for taking the question and apologies for the connection issue I was having before. I was hoping to speak more on the electric vehicle opportunity and I think the content is about double in an EV for TEL compared to a traditional car. Now that you're seeing a number of EV startups come to market, are you seeing a similar type of content opportunity with some of those customers? And then maybe also just talk about any differences on margins and market share as this is an evolving landscape, there would potentially be the opportunity to do more of a solution sale with newer entrants into the industry, but also perhaps that they're also looking to bring in nontraditional suppliers? So any kind of comments around not only the content opportunity, but also margins and market share? Thank you.

Yes, sure, Mark. It's a question we get a lot and I'll try to frame this here. In many ways, it comes into not only where we innovate, but it comes into their strategy that how do they want to make the car? In some cases, we've shared examples where we have $500, $600 on an EV product [indiscernible] looking to others to do the assembly and more of the manufacturing form. We have ones that have $200 where we're playing much more like our traditional component players. So I think as that space evolves, I think that's why you see the wide variation. But even on the component side, the component side is where we get – we typically stick to the 2x, the opportunity. We also when you comment on the margin, you have to say where do we bring value and where do we bring our engineering? We are not a contract manufacturer. We do not view ourselves as a Tier 1. So that's not been part of our strategy. So it's why we typically tell you 2x. But I will tell you the opportunity is not just with new startups, it's also the strategies of every one of the OEMs as they come up and figure out how they want to assemble the vehicles versus traditional. And in some cases, we do more in other places we play our component role and either way it creates opportunity for us that drives the content and will [indiscernible] because we know the architecture so well. And there is existing architecture that goes into electric vehicle that we get content, not just the high power products, that's why we get such content opportunity over the combustion engine as well as the electrical powertrain.

Okay. Thank you, Mark. Can we have the next question please?

Your next question comes from the line of Matt Sheerin with Stifel.

Thanks and good morning. Terrence, another question on the auto market. You talked about Q1 being a peak largely because of China seasonality. Do you have any thoughts on what the production number looks like for your FY '21 and how you see North America and Europe playing out in terms of their catch up on production? And then also sell-through there?

As we look at, Matt, I know I said visibility is limited. And what I'd like to keep it to is probably the latter part of your question on sell-through. And we talked about in other calls. The element is it's good to see production recovering. But the real proof in the pudding is, are people buying cars? And what has been nice, if you go in Asia and LatAm, we had concerns of what was pent-up demand versus ongoing sell-through. And China, as we’ve seen from the figures, has stayed pretty consistent with the sell-through and the inventory levels in China are at very normalized levels. In Northern America, certainly production is ramping. We also see that the demand is nice and inventory levels are at a comfortable spot. The one area where we'd say inventory is still elevated is Europe. Some of that, we've also told you, relates to with the regulatory changes there between EV and combustion engines. I do think the consumer has been a little bit more cautious on vehicle purchases. So that's the one area that we continue to look at to say, hey, we'd like to see inventory work down. We like the structures and some of the incentive programs governments have put into place to really do cash for comfort type programs and [indiscernible], but we still need to see inventories come down in Europe.

Okay. Thank you, Matt. Can we have the next question please?

Your next question comes from the line of Chris Snyder with UBS.

Thank you. So the company's capital intensity has picked up over the last couple of years, which I assume is largely driven by the scaling of EV capacity. But should CapEx intensity come down as we kind of look out the next couple years, just as build winds down? And then what does this level of investment mean for competitive positioning within the EV market, as it seems like smaller competitors will have trouble matching this level of investment? And could that – then could that transition, further add to the moat around the business?

Thanks, Chris. We did heighten up or tick up our CapEx investments. If you go back a couple years ago, we were running – we’re up north of $900 million. I think you've seen that number certainly come down over the past couple of years. And I would say our viewpoint as we look at FY '21 is consistent, you should probably think about somewhere around that 5% of revenue in terms of our CapEx intensity certainly no more than that. One of the things we do benefit from is, as we were increasing our capacity and that’s both to support the traditional combustion engine customers, but it was heavier weighted towards some of the EV fit up in our factories, certainly we're able to now utilize that. That was done under the assumption of significantly higher auto production than what we saw on FY '20 and anticipate in FY '21. But we are able to utilize some of that capacity as we bring some of these plants offline. We're talking to you about restructuring dollars to take some of these plants, primarily in Europe offline. You don't hear us talking about incremental CapEx on the receiving end of where that activity is going to go because that's already in place. And the second part of your question around does this differentiate us versus others? I certainly think it does. I can't give you – speak on behalf of other companies and what their capital structures are in terms of some of the smaller players, but I can tell you that it is – there is particularly on the frontend a fair amount of capital investment, both on the CapEx side as well as on the engineering front to support these customers, particularly as Terrence noted, as it's an evolving area in terms of what actually is going to be produced where and who's going to do what. And I think we're very well positioned. And as you know, make money in this business, it's all about scale. And it's about having the ability to handle the customers' needs and be able to ramp production at full scale. And that's what we're good at.

Yes. Heath’s exactly right. It is important. While there are startups, you still have to get the price point and where the consumer is there and scale, it is a big advantage. It is something that when you think about scale, there's two elements of scale in our business model that to your point used the word [indiscernible] was very important. It is the element of how you deploy the engineering resources against where those designs are happening. And then there's a backend scale, part of it is how do you make sure that manufacturing, what you design, you bring scale in the automotive business where the customer wants the supply chain to be. The automotive business is still adjusting on business, and it's very important that the scale that you bring is where they’re selling the vehicles. And in some cases, what starts as maybe they think they're going to penetrate one part of the world, they want to – may take off in another part of the world the platform, and how do you bring scale for continuity, because it is still an industry that wants to make sure it's quality and that element, and they also want to make sure they can get the product to cost point their [ph] car that somebody can afford. So it is the scale element as EV scales. I think it's the biggest opportunity we have and also one we've signed up for how do we make sure that we bring scale to.

Okay. Thank you, Chris. Can we have the next question please?

Your next question is from the line of William Stein with Truist Securities.

Great. Thanks for taking my question. I'm wondering if you can remind us what the annual pricing negotiations in automotive look like when they occur, how pricing typically trends through these negotiations and maybe how the current negotiation puts a compare to what you think they do with in a typical year? As I recall, during these times of dislocation, that can be sort of unusual discussions around that topic. Thank you.

Pricing across the portfolio is slight deflation. And in auto, auto is typically one that it is annual discussions that are based upon volume as well as opportunities and those discussions typically happen late in the calendar year, early in the following calendar year. So they'll be upon us. And certainly when you think about 2020, there's a lot of volume commitments that weren't made as well as how we're ramping a lot of things so that they are very strategic discussions we have with our customers also come into how are we doing on where we invest engineering. And with where the world is, I don't see them being more price deflationary than normal. I think it will be real active discussions that we have as we get in those discussions with our customers.

The reason I asked is I recalled the credit crisis, there was also an expectation that you'd see normal price reductions even though the customers were not meeting volume commitments. So that's sort of where I was headed with that. Do you think we'll see normal deflation this year as we have in other years, even though the volumes might not have been that in the prior year?

I think we'll have some deflation, because of the automotive market. I'm not sure it will be normal. And then we have to get through those discussions with our customers.

Thank you.

All right. Thanks, Will. Can we have the next question please?

Your next question is from the line of Joe Giordano with Cowen.

Hi. Good morning, everyone. One thing I just wanted to clarify first, Terrence, you mentioned inventory levels in Europe. Can you just clarify, are you seeing customer – market demand satisfied out of customer inventory right now? And then my remaining question is a little bit more high level. You see something like GM coming out with a big new EV platform and plan to spend a lot of money? Can you just talk to me about how might that relationship with a customer like that kind of evolves through their kind of planning phase and how early are you involved with something like that? And how would that be similar or different to some of the startups that Mark mentioned earlier?

So you have a couple of questions there. So let me take the first one. What's been nice? Car registrations have improved in Europe. So when you sit there when I talk about inventory, it's really – think about that deal a lot. It was heavy coming in. Certainly COVID impacted it and we've talked about that. So what I would say is, it's really making sure that [Technical Difficulty] so that was really my comment around Europe. When you think about a program, a program and it isn't just one car or one plan, it really starts at the platform level. And those discussions happen as we're in the design element of the electrical architecture. We’re the data architecture. And in some cases, what occurs is they're taking product off the traditional platform that they say is good enough, that can be interconnect on a light, because the change really between combustion engine and the electrical vehicle, and how they actually start working their platforms. And those can take years, depending upon where they get to the platform element. And once you're on the platform that can say how they evolve the platform. And certainly I think when you talk about EV when you have a startup, they're basically starting with a model. Larger companies really have platforms. And you are seeing some of our larger customers come out with platforms. You see much more advertisement around the world on it, and in some cases it’s due to the regulations that they have to meet. But it's also about where they see the market going. And I think it's pretty consistent what we laid out. So is it different than how we innovate today? No. But what I would tell you is the urgency and the pace on those platforms have certainly kicked it much faster than the design cycles that you would have had on a traditional evolutionary combustion engine. You do see how they're focused very much on EV. You see our autonomy [ph] has taken a little bit of a step back during the downturn. Our customers are very focused on the electric powertrain. And they're also seeing the opportunities of where they are in the world. So you see people very much want to be penetrating China as well as the high end areas, which are some of the vehicles that we talk a lot about, on very high-end vehicles.

Okay. Thank you, Joe. Can we have the next question please?

Your next question comes from the line of Steven Fox with Fox Advisors.

Thanks for taking my question. Good morning. Terrence, you talked a lot about the EV side. I was wondering if you could just sort of focus on the legacy CO2 side of the business since it's still so big. Where would you be getting the content growth from there? I assume there is still some content growth. And then just specifically with CO2, how do you manage it as your customers seem to be dramatically increasing on the other side of the business? Thanks.

Well, it's really two factors. You still have electrification that happens on a combustion engine. When you look at TE and you think about TE, other than on the engine, other than where you get into the ECU element, powertrain is not as big of a content element per house as other things like you have on an EV platform. So where we get content is continued comfort features. Certainly the data architecture that's being built into a car as you move up the levels is going to happen in both a CO2 engine as well as an electric vehicle. So that element that comes into the data architecture continues to evolve. Certainly the sensing you have on safety and the features that we all rely on. So, while the development of combustion engines aren't as strong as they used to be, because people are going to EV, the other features we're getting in the car that do provide, like we've talked about when we've had done some of our Analyst Days, 200 or 300 basis points of content above production in a core engine is still occurring. And those programs – as the data architecture puts in comfort features get added as well as just the whole ECU network evolves, we typically see more contacts being added on the car than less. And the only other thing I would say on the combustion engine is we also see our customers leading us more on that legacy electrical architecture, because they want their engineers working on figuring out the electrical platforms.

Great. That’s helpful. Thank you.

Thank you, Steven. Can we have the next question please?

Your next question comes from the line of Jim Suva with Citigroup.

Thank you.

Hi, Jim.

If you could take the opportunity maybe to clarify before there's any confusion about the peaking in the December quarter. My memory that auto production typically, generally always peaks in December, but people are going to be concerned that it's going to be your peak earnings per share. And I think Heath mentioned that that's not necessarily the case. But it turns out there may be some hedging around that. I know you're not getting the full year guidance, but can you just kind of help us think about that? Because I can sense a lot of people are actually thinking that the peak of your earnings per share and the story on that. So if you could maybe walk us through that a little bit.

Jim, thanks, and you said it right. 21 million units in the December quarter I think for the past five years has been the peak production globally. So when we look at the 21 million we expect in the first quarter, we do expect that to be the high point. But that doesn't mean it's the high point for EPS, Jim. That's just auto production estimate. And it's the high point as we look into '21. So, like I said during the call, we still think a gradual recovery of our markets is the right way to look at this. Certainly, we like that the recovery in auto production is quicker than we expected and I think that most people expected, but we do also have to realize that the first quarter is typically the high point of auto production in the year due to the effect of China and how China is the largest car producing country on the planet.

Okay. Thank you.

Thanks, Jim. Can we have the next question please?

Your next question comes from the line of Joseph Spak with RBC Capital Markets.

Thanks. Good morning. This is actually Derek Neldner [ph] on for Joe. Thanks for fitting me in. I guess just continuing on the electrification, maybe shifting gears to commercial transportation. I think historically, you've talked about commercial transportation, CPV growth being a little bit below the 4 to 6 you kind of experienced and target in auto, but maybe just update us on kind of where we are on that journey in terms of making commercial transportation outgrowth getting closer to the 4 to 6 in auto, what the prospects are for next year, given we're seeing more kind of electric commercial transportation programs come to market? And then kind of what your conversations with customers have been recently around broader electrification within commercial transportation?

When you look at commercial transportation, it is a very broad market. So you're dealing with agriculture, you're dealing with construction vehicles, certainly you're dealing with truck and bus. And when you look at electrification, you do see it much more on the short-haul delivery. Certainly you see people on some longer-haul experimentation. But at the rural market, when you deal with electrification, the impact won't be as broad as you're having in the auto space. That being said, we do see a lot of content and it's both electrification as well as data autonomy, because the features you have in the truck and bus space doesn't have more data uses because you get into fleet management, how they think about their business models. And what's been nice over the years is what our ICT business which historically would have been probably moving much more with underlying production, we have through the EV as well as data have created content separation. And I think you've seen that this year. We also expect, as you get some of the things that are happening globally, in China we do expect to be a little bit of a headwind, but we do expect other parts of the world to be able to make up for that partly plus our content is really going to be due to the content opportunity in ICT. I do still -- we still do believe it's below the 4% to 6% in the car, but it is something that's going to be a big content driver for that business.

Okay. Thank you. Can we have the next question please?

Your next question comes from the line of Luke Junk with Baird.

Thanks for taking my question. So wondering if you could comment on medical-related puts and takes as we go through another rise in COVID cases, what factors needs to align to get this business back on a growth trajectory as you've outlined.

When you look at it, realize where we've pointed our business has been very much interventional procedures. And if you look at our customers, they've been impacted around it and they've also are working off inventory. So when we look there, we still see the procedures that we’re very much around being down. We have seen recovery. We would probably say the recovery plus as they work off inventory, you're probably looking more at the latter half of our '21 based upon what we know today, but that could be impacted based upon COVID or any other market developments. But I think we're probably in the middle of it as we speak.

Okay. Thank you, Luke. Can we have the next question please?

Your last question comes from the line of Nik Todorov with Longbow Research.

Thank you for taking the question. You guys talked about the December quarter auto production peaking at 21 million. I know visibility is limited. But I'm guessing how you're thinking about the low point of auto production into the next fiscal year? Could we get down to 17 million, 18 million vehicles a quarter? I'm just trying to understand how are you thinking about probabilities? And then can you give us just a breakdown of production and growth year-over-year into the December quarter by geography? Thanks.

Yes, we aren't guiding for the year. And I guess on the first point, I’d ask you to look at third party resources on your first part of your question. When we look at the first quarter though where we are guiding, there is an element even in the first quarter at the 21 million units. That will still be down year-on-year versus around 22 million units last year. We see every geography still being down year-on-year, but certainly at a lower rate than we've been experiencing. So as you look through the geographies, even though China continues to go up to its first quarter, we do expect China production to be down year-over-year and we also expect the other regions of the world. I do think it's important to realize how – we like this recovery, but we still – some of the regions we highlight where we're at is we're still below where we were at in 2019. And what we're very focused on is how do we make sure we adjust to the world, not only in auto and elsewhere to the world of post-COVID that we're still trying to figure out. So still it's nice to see the sequential recovery up to the 21 million units versus where we were two quarters ago at 12, and we’ll continue to keep you updated as we go through the year. And we still expect a gradual recovery.

Okay. Thank you. It looks like there are no further questions. So I want to thank everybody for joining us on the call this morning. If you have additional questions, please contact Investor Relations at TE. Thank you and have a nice morning.

Ladies and gentlemen, the conference will be available for replay beginning at 11.30 AM Eastern Time today, October 28, 2020 on the Investor Relations portion of TE Connectivity’s Web site. That will conclude your conference call for today.