TE Connectivity Ltd. (NYSE:TEL) Q4 2023 Earnings Call Transcript

TE Connectivity Ltd. (NYSE:TEL) Q4 2023 Earnings Call Transcript November 1, 2023

TE Connectivity Ltd. beats earnings expectations. Reported EPS is $1.78, expectations were $1.76.

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

Sujal Shah: Good morning, and thank you for joining our conference call to discuss TE Connectivity’s fourth quarter and full year results for fiscal 2023 and outlook for our first quarter of fiscal 2024. 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.

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I also want to remind you that our Q4 results in fiscal 2022 included an extra week. In this call, year-over-year income statement and orders comparisons for Q4 and fiscal 2023 are made excluding this extra week. You will find related reconciliations in the press release and presentation tables. Finally, during the Q&A portion of today’s call, we’re asking everyone to limit themselves to one question, and you may rejoin the queue if you have a second question. Now let me turn the call over to Terrence for opening comments.

Terrence Curtin: Thank you, Sujal and we appreciate everyone joining us today. And to start off, I am pleased with what — that we delivered revenue in line with our guidance and earnings per share that was ahead of guidance, driven by strong execution by our teams across our segments in what continues to be a dynamic market environment. Before we get into the slides, I do want to take a moment to discuss our performance for the full year, along with what we’re seeing in the markets versus our last call. When we look back on fiscal 2023, we set out to accomplish three key initiatives that we shared with you. First was to continue to demonstrate the strategic positioning of our portfolio through alignment to secular growth trends.

Second was to deliver strong free cash flow with a focus to drive down inventory levels. And lastly, to improve our margin performance through both cost reduction and pricing actions to offset inflation. As Heath and I will discuss on today’s call, our teams executed successfully on all of these initiatives during the year, and it sets up for a good jumping off-point as we enter 2024. When we think about the performance of the portfolio, our results demonstrated continued growth in the Transportation and Industrial Solutions segments, which offset market weakness in Communications and headwinds from a stronger dollar. We generated growth above the market and a number of our businesses as we continue to benefit from secular trends, including increased global production of electric vehicles, adoption of renewable energy, and applications for cloud as well as artificial intelligence.

We delivered record free cash flow of $2.4 billion for the year which represents over 110% conversion, and we also returned $1.7 billion to shareholders for the year. We drove down our inventory levels in response to improvements in our supply chain. And at the same time, we improved our service levels to our customers. Our cash generation model gives us both confidence as well as opportunities to return capital to shareholders and support bolt-on M&A activities which is aligned with our use of capital strategy. We also worked to drive margin expansion in the second half of 2023, and we delivered on this commitment. We improved our exit rate on adjusted operating margins to above 17% as we close the year, despite our Communications segment being in the bottom of the cycle.

Now, let me share what we’re seeing in our market since our last call 90 days ago. And on an overall basis, markets are playing out as we expected. We have most of our key end markets on a growth or recovery trajectory with a few markets continuing to cycle as we previously discussed with you. Our view of Transportation end markets remains consistent with our prior view with global auto production remaining stable. Our growth will continue to be driven in Transportation by content outperformance that leverages our leading global position in this market. In our Industrial segment, three out of our four businesses continue to have growth momentum. You see our strong positioning in renewable energy with growth from both wind and solar applications.

Commercial air sales continue to grow as this market recovers, and our medical business is benefiting from increases in interventional procedures. And in our Communications segment, while sales are down significantly versus last year’s cyclical peak, we saw a sequential growth in orders in our fiscal fourth quarter due to early ramps of artificial intelligence programs and we continue to expect volume growth from AI applications as we move through 2024. And finally, I do want to reinforce that the way that we think about long-term value creation remains unchanged. It is built on the pillars of secular growth trends that will drive increased content in the markets where we position TE, strong free cash flow generation with discipline around how we deploy capital and certainly levers up to enable margin expansion as we move forward.

So, with that as an overview, I’d answer that you turn to Slide 3, and I’ll get into the presentation and I’ll discuss some additional highlights for the fiscal fourth quarter as well as the full year, and Heath will get into more details during his section. Our fourth quarter sales were $4 billion, which was in line with our guidance. Transportation segment organic growth of 5% was offset by declines in Communications due to the ongoing market weakness that we’ve been discussing. Adjusted earnings per share was ahead of our guidance and up 2% versus the prior year at $1.78 with adjusted operating margins of 17.3%. Cash flow from operations was a very strong $1.1 billion and free cash flow was $945 million in the fourth quarter, and both of these were quarterly records for the company and I think this just reinforces a strong execution by our teams, I already highlighted.

For the full year, sales of $16 billion were flat on a reported basis, and we had organic sales that were up 3%, and this 3% organic growth was driven by our Transportation and Industrial segments. Adjusted operating margins were 16.7% for the full year. But on the margin side, the real highlight was that we expanded adjusted operating margins by 120 basis points from the first half to the second half of the year due to our team’s execution. As we look forward into the first quarter of fiscal 2024, we are expecting that first quarter sales will be $3.85 billion and adjusted earnings per share to be around $1.70. On a year-over-year basis, we expect sales to be flat with organic growth in our Transportation and Industrial segments. We do expect adjusted EPS expansion of over 10% in the first quarter and strong margin expansion as well year-over-year.

So, if you could turn to Slide 4, let me discuss order trends and what we’ve seen. We continue to benefit from markets with strong secular growth trends, and this is offsetting weakness in markets that are cycling or being impacted by inventory destocking. At the total company level, we continue to see stability in our order levels. Orders of $3.9 billion in the fourth quarter were consistent with order levels for the past several quarters, and our backlog remains near record levels. Transportation orders grew both year-over-year and sequentially, reflecting ongoing stable global auto production. Industrial order patterns reflect some seasonality across this segment as well as ongoing destocking in the Industrial Equipment end markets And I ask you to keep in mind that 50% of our Industrial Equipment business does go through the distribution channel, and we expect that destocking here to continue for the next couple of quarters.

In the Communications segment, while we continue to see our customers work down inventory in their supply chain, we had our second consecutive quarter of sequential order growth which is being driven by new orders for artificial intelligence applications. So, with that as an overview of orders, let me now get into year-over-year segment results in the quarter. that are shown on Slides 5 through 7, and you can see the details on each one of those slides. So, starting with Transportation. Our sales growth remained strong. It was up 5% organically year-over-year, and it was driven by our automotive business. In our automotive business, we grew 9% organically with growth in all regions. Our performance continues to be driven by our leading global position in electric vehicles, electronification trends within the vehicle as well as positive impact from pricing.

In fiscal 2023, electric vehicle and hybrid-electric vehicle production grew globally by approximately 40%. Most of this growth was driven by Asia, and we expect this region to continue to be the growth driver for electric vehicles. As you know, we generate approximately 2x the content in electric vehicle platforms versus combustion engine vehicles. So, we expect our content per vehicle to continue to expand as we move forward. Overall, we expect auto production next year to be about 21 million units per quarter with continued growth in hybrid and electric vehicle production. In our Commercial Transportation business, we did experience a 7% sales decline, which was in line with what we expected and was driven by market weakness in both North America as well as China.

And in our Sensors business, we saw growth in automotive applications that was offset by weakness in industrial applications. At the margin level for the Transportation segment, adjusted operating margins were 18.4% as we expected and up 170 basis points year-over-year as our teams executed on the cost and price actions that we’ve been highlighting to you. Now, let me discuss the Industrial Solutions segment. And while sales were flat in the fourth quarter, I think what’s really nice as you look at the slide is that we have three businesses that are continuing on a very good growth trajectory. Our Aerospace, Defense and Marine sales were up 14% organically, with ongoing improvement in the commercial air market. In Medical, sales in the quarter were up 19% organically, driven by ongoing increases in interventional procedures.

And in our Energy business, as you know, we positioned this business around renewables, and you’re seeing the benefit of this again this quarter with 6% organic growth. Finally, in the Industrial Equipment business, our sales were down 21% organically driven by the continued inventory digestion in the distribution channel, a trend that is similar to what you’re hearing from other companies. Adjusted operating margins were 15.9% in the quarter, reflecting the impact of expected volume declines in the Industrial Equipment business. So, let’s turn to Communications, and while our organic sales were down 27% year-over-year, they were up 9% sequentially to $463 million. We are seeing the benefits from the early ramps of artificial intelligence programs, which will strengthen as we move through 2024 and beyond.

Adjusted operating margins were 15.3% for the segment and an increase of over 100 basis points sequentially. And as we see destocking and AI increases in volume, you’ll see margins expand in this segment as we move through 2024. So, with that, let me turn it over to Heath, who will get into more details on the financials as well as our expectations going forward.

Heath Mitts: Thank you, Terrence, and good morning, everyone. Please turn to Slide 8, where I will provide more details on the fourth quarter and fiscal 2023 financials. Sales of $4 billion were flat on a reported basis year-over-year. Adjusted operating income was $699 million with an adjusted operating margin of 17.3%. GAAP operating income was $635 million and included $57 million of restructuring and other charges and $7 million of acquisition-related charges. For the full year, restructuring charges were approximately $260 million, which were in line with expectations. Our restructuring efforts over the last several years have enabled a more efficient operating footprint, while continuing to localize to support our customers in the regions of the world where they operate.

I expect restructuring charges to decline significantly in fiscal 2024 and to be approximately $100 million for the year. Adjusted EPS was $1.78 and GAAP EPS was $1.75 for the quarter and included a noncash tax-related benefit of $0.16 related to a decrease in the valuation allowance. Additionally, we had restructuring, acquisition and other charges of $0.19. The adjusted effective tax rate was approximately 19% in both Q4 and fiscal 2023, which was as expected. For Q1 and for fiscal 2024, we expect our adjusted effective tax rate to be roughly 20%. And as always, importantly, we continue to expect our cash tax rate to stay well below our adjusted ETR for the full year. Turning to Slide 9 for additional information on our full year performance.

Fiscal 2023 sales were $16 billion, while sales were flat year-over-year, we had 9% organic growth in Transportation segment and the Industrial segment grew 5% organically despite the softening in the Industrial Equipment business. However, the growth in these two segments was offset by roughly $1 billion of headwinds from the cyclical weakness in the Communications segment that we’ve discussed, combined with the impacts from the stronger dollar. Stronger dollar negatively impacted sales by approximately $430 million versus prior year. And due to the further strengthening of the dollar against other currencies, we expect year-over-year currency exchange headwinds of approximately $250 million in fiscal 2024. Adjusted operating margins were 16.7% for the full year with margin expansion of 120 basis points from the second half of the year — I’m sorry, 120 basis points from the first half to the second half of the year driven by both cost reduction initiatives and price increases.

And this was most evident in our Transportation segment, our margins expanded over 200 basis points from the first half to the second half, exiting the year in the mid-18% range. At the company level, we exited the year with adjusted operating margins of 17.3%, and we expect to expand from this level in fiscal 2024. Adjusted EPS was $6.74 and included a $0.45 headwind from currency exchange rates. Turning to cash, we generated record free cash flow of approximately $2.4 billion in fiscal 2023, and with roughly $1.7 billion returned to shareholders through share buybacks and dividends. Free cash flow was up 35% year-over-year with over 100% conversion to adjusted net income, and we expect to generate approximately 100% free cash flow conversion going forward.

I am pleased with the progress our team has made in reducing inventory levels through the year, which contributed to our strong free cash flow. Our cash generation model, coupled with our strong balance sheet will enable us to continue to be aggressive with capital return to shareholders while pursuing bolt-on acquisitions, including the Schaffner acquisition that we expect to close at the end of this quarter. Before I turn it over to questions, let me reinforce some of the key points that we discussed today. While markets remain dynamic, we are continuing to take action on the things we can control to improve our financial performance. We worked hard to get to a better exit rate on margins at the end of the year but we still have work to do to get to our business model of margin targets.

We do expect to make progress on further margin expansion and EPS expansion this year. Most of our end markets have a growth or recovery trajectory and we expect the destocking that we have seen to improve as we go forward. Our balance sheet is solid. We are demonstrating our strong cash generation model, and we remain excited about the opportunities we have ahead of us to drive value creation for all stakeholders. So, with that, let’s open it up for questions.

Sujal Shah: Audra, can you please give the instructions for the Q&A session.

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Q&A Session

Operator: Thank you. [Operator Instructions] We’ll take our first question from Mark Delaney of Goldman Sachs.

Mark Delaney: Yes, good morning and thanks for taking my question. There’s been so many crosscurrents and various end markets including in the UAW strike, inventory destocking in industrial and content opportunities like AI and electrification. So, I’m hoping you could help us better understand in a bit more detail key trends by end market and what you expect going forward, including your assumptions by end market in 1Q guidance?

Terrence Curtin: Sure. Thanks Mark. So, let’s talk about quarter four first a little bit because we went through a lot there and I think when you look at on the top line, it came in exactly as we expected. What was a little bit better than we would have expected, certainly, automotive, where we had growth in all three regions of the world as well as in our D&D and our Communications segment was a little bit stronger due to the ramps of artificial intelligence that I mentioned in my comments. The area that was a little bit weaker was Industrial Equipment. And we highlighted for you last quarter, we were seeing some inventory destocking around channel partners. I would say that was a little bit worse and we think that’s going to be with us for a little bit.

And then certainly, we were head on EPS, and that was really driven on the conversion side in all operational. When you look at quarter one and our guide, in many ways, it’s going to look a lot like quarter four. We’re going to continue to have growth in Transportation. Three strong markets in industrial with the inventory stocking and Industrial Equipment. And then you still have some tough compares that we have in the Communications segment, but net-net, it’s going to be flat on the top line year-over-year, and you’re going to see margin that looks like the fourth quarter, and you’re going to see really nice EPS growth year-over-year, that’s 10%. So, orders have been coming in as we expected this quarter to 3.9, have been stable even with some of the destocking we’re seeing, orders are staying stable.

And I think that just shows the trends that you highlighted as we go into 2024. So, thanks for the question, Mark.

Sujal Shah: Hey thank you, Mark. Can we have the next question please?

Operator: We’ll go to Wamsi Mohan at Bank of America.

Wamsi Mohan: Yes, thank you. Good morning. Terrence, can you sort out some of the puts and takes in autos, given all the recent news around the D3 companies paring back on EV ambitions and potentially slower adoption rates of EVs? And also, you didn’t explicitly call out the UAW strike. Did you not see any impact? Or is it yet to come in terms of any impact from that? Thanks so much.

Terrence Curtin: Thanks Wamsi for the question. And you really had two very different questions there. So, let me take the latter part first, around the UAW. UAW impact on TE’s negligible both in what, in the fourth quarter as well as the first quarter. And just to remind everybody, our global position is what’s special about our automotive business. 80% of our business is outside the United States. And let’s face it, that has no impact from the UAW. So, when you sit there, I don’t — we did not talk about it because it did not have a significant impact, and we don’t expect it to have a significant impact in the first quarter. Now, let’s move on to your EV question. And probably similarly, I’m going to remind everybody that we need to make sure when we think about EVs. EVs got up to 20 million units produced globally this year with two-thirds of those EVs made in Asia.

And once again, reinforcing our global position. And EV adoption is never going to be a complete straight line up to the right. But what’s really nice is you see with 20 million units made and on the road, the technology is working. It is being adopted. And the other thing you have is you certainly have consumers have choices and some EVs consumers are going to like, some EVs they’re not going to like. And I think when you think about our opportunity, it is to build upon how the content opportunity that goes up that you saw this year — and when as EVs grow next year, we’re going to continue to get that. And in a full electric vehicle, we get 2x the content of a combustion engine. If it’s a hybrid vehicle, it’s about 1.5x. And we expect you’re going to continue to see electric vehicles grow globally again next year.

Maybe it won’t be a 40% clip like this year, but it will increase next year. And let’s face it in Asia, the biggest market is China. And China EV sales this year are up over 30%. On top of that, I’ll remind you that China local OEMs have over 50% market share. They’ve continued to gain share versus Western OEMs. And what’s really nice for TE, our content on a local EV by China OEM is strong, and our market share is strong. So, we don’t have the phenomena we only are with the multinationals and not the local OEMs. So, feel very good about our position. I feel that EV trend is going to continue to have production growth globally as well as you’re going to see that benefit like you saw this year and for the past couple of years, it’s going to drive top line growth opportunity for TE as well.

Sujal Shah: Okay. Thank you. Wamsi — thanks Wamsi. Can we have the next question, please?

Operator: We’ll go to Steven Fox at Fox Advisors.

Steven Fox: Hi, good morning. I was just wondering if you could dig in a little bit more into free cash flows. Obviously, you guys overperformed over 10%. Can you just talk about some of the dynamics that went into that? And then the expectations for cash flow this year, any of the dynamics and maybe talk a little bit about use of excess cash. It seems like it’s — the strategy is the capital allocation is consistent, but you did do an acquisition during the quarter. So, maybe that was [indiscernible]. Thanks.

Heath Mitts: Well, Steve, thanks for the question. This is Heath. I’ll take it. So, we talked a fair amount about free cash flow during the year, and it was during our fiscal 2023, and it was a focal point for us internally as well as what we’ve talked to you about. We know that we had to deal with the supply chain issues in the prior couple of years and we had to buffer some inventory as part of that. As we went into this year and as demand flow and so forth begin to stabilize and then our supply chain with our vendors begin to stabilize some. It allows us the opportunity to get really focused on driving working capital down despite some of the market conditions. So, I’m pleased with how we did, how we finished the year, but also provides some confidence as we go into FY 2024, which we’re in right now, starting here in October that we’re going to be able to maintain that momentum.

The 112% conversion that we did in FY 2023 was a little rich, If I am being honest, it’s a little bit richer than I would have thought we would have finished, but proud of our performance. As we think about 2024, I’m confident we can cover around a 100% mark in terms of cash conversion, which is a bit of a step-up from where we historically have trended. And it does avail a lot of optionality for us. You mentioned, Steve, that our capital allocation strategy is unchanged, and that is absolutely true. You should expect that we will continue to be diligent with the cash flow that’s available to us. We will get back to our shareholders as appropriate and step up repurchase activity where it makes sense and when there’s dislocations in the market relative to valuations.

And so I don’t think there’s anything there that’s different. You mentioned the acquisition we have coming up at the end of December. That’s about a $300 million use of cash that will come off the balance sheet. But we also expect to be generating cash as we go along here in the first quarter as well. So yes, it’s very, very positive momentum along those lines. Hopefully, I answered your question.