TE Connectivity Earnings Call INSIGHTS: Transportation Carries the Load, Channel Softness

On Wednesday, TE Connectivity Ltd (NYSE:TEL) reported its third quarter earnings and discussed the following topics in its earnings conference call. Take a look.

Transportation Carries the Load

Amit Daryanani – RBC Capital Markets: Just two questions. When you look at the operating margin profile, you guys have clearly done a good job hitting the 14% target on Sub, $3.5 million revenue now. The mix, it looks like margin of just Transportation has been doing a lot of the heavy lifting. How do you think of margins for the other two segments and could you maybe talk about what gets the other two segments to 14% op margins in terms of revenue run rate or further cost initiatives, especially in the Network Solutions side?

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

Amit Daryanani – RBC Capital Markets: Then, Tom, maybe I’m reading too much into this, but I think you said you guys intend to return two-thirds of free cash flow back to shareholders. That seems a higher number at 67% versus in the past you’ve talked about 50% to 60%. Could you verify that and then would the split between buybacks and dividends change on a go-forward basis?

Thomas J. Lynch – CEO: Well, as I said, we ran about 55-45 return to M&A in the first five years, and if my memory serves me right, about two-thirds of the return was buyback and one-third dividend. So dividend is about $1.4 billion and returns about $2.9 billion in that period. I do think because we’ve made two significant acquisitions that really filled the two key strategic areas that almost by definition going forward that there will be much more focus on a consistent return on capital and bolt-on acquisitions. I would never say never, but that’s why I say, when you think in terms of the model, the 55% to 60% to 70% is how I think of it as a return. I would expect that to continue to raise the dividend as long as global economies are sound and our earnings are, we’ll keep in line with our target dividend yield. So, I hope that answers your question.

Channel Softness

Matt Sharon – Stifel, Nicolaus and Company: Just a question on the commentary on the CIS business and specifically the channel softness. Obviously you went through an inventory correction there and it sounds like distributors are being more cautious, but what does sell-through look like, and then inventory levels, are they bringing down inventories yet again or are they just being super cautious here?

Thomas J. Lynch – CEO: Matt, I think it’s more the latter supper cautious. A quarter ago when we were all together I think we were feeling cautiously bullish as the inventory correction was over and we saw in Q2 and in Q3 actually the left in sequential revenue through the channel and there sell-throughs were going up, but as this slowdown began to happen in mid-May, with the U.S. jobs peaking and all those other things, everybody is just starting to dial back a little bit. I don’t think the inventory in the channel a problem. I think just that, what we’ve gone through over the last five years a couple of time collectively everybody is managing that much more closely and including ourselves where our inventory days are actually down this quarter. I think it’s just everybody’s a little bit gun-shy.

Matt Sharon – Stifel, Nicolaus and Company: Are you getting the sense that the distribution point of sales has weakened as well going into this quarter?

Thomas J. Lynch – CEO: No. I think the slope has just changed. It is ramping and now it’s flattening and I think that just – leading the caution.

Matt Sharon – Stifel, Nicolaus and Company: Then on the OpEx side it looks like you’re holding margins fairly well given the volume softness across different parts of your business. If we are in this sort of component cycle that’s stuck here and we continue to see softness, are you looking at other cost-cutting measures whether it be in CIS or other businesses, particularly networking where it doesn’t look like things are bottomed yet?

Thomas J. Lynch – CEO: I would say Matt. I think as we proved over the last year, if we do we will continue to assess where are we from a volume level and we will take actions as appropriate. So I think what you can expect and I think what you saw like we did in CIS over the past year, CIS was an area that we had to adjust it. We are happy that in the third quarter we are back to prior year OI levels, even on lower volume essentially and we’re going to prove it. So we see markets change that fundamentally, we sort of had a higher level that we will take – will evaluate (for the) cost out.

Matt Sharon – Stifel, Nicolaus and Company: So, it doesn’t sound like you’re at the point now where you’re ready to do that? You feel like things are getting materially worse. Is that fair?

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