TE Connectivity Ltd (TEL) Q4 2018 Earnings Conference Call Transcript

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TE Connectivity Ltd  (NYSE:TEL)
Q4 2018 Earnings Conference Call
Oct. 31, 2018, 8:30 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the TE Connectivity Fourth Quarter and Final Year Results Conference Call. All participants are in a listen-only mode. Later we will conduct a question-and-answer session. (Operator Instructions)

I would now like to turn the conference over to your host, Sujal Shah, Vice President of Investor Relations. Please go ahead.

Sujal ShahVice President of Investor Relations

Good morning, and thank you for joining our conference call to discuss TE Connectivity’s fourth quarter and full year 2018 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, 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.

Please keep in mind that we announced the sale of our SubCom business last quarter and expect the transaction to close by the end of this quarter. With the sale, SubCom is reflected as discontinued operations and is not included in our results for guidance. Also, prior periods have been recast to reflect SubCom’s discontinued operations treatment. In our fiscal 2018, SubCom generated approximately $700 million in sales, with a minimal contribution to adjusted EPS.

Note that all prepared remarks on today’s call will reflect TE continuing operations, unless otherwise noted. We’ve included slide 15 in our earnings presentation, which shows recast financial information for continuing operations. 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 and ask that you rejoin the queue, if you have a second question.

And let me turn the call over to Terrence for opening comments.

Terrence CurtinChief Executive Officer

Thank you, Sujal and thank you everyone for joining us today and I’ll cover our 2018 results as well as our outlook for 2019. As we are going to be going through both our fourth quarter 2018, as well as the full year ’18 and the guide. I’d like to start with framing the key messages for today’s call by referencing our long-term business model.

To remind you, back at our Investor Day earlier this fiscal year, we conveyed a long-term business model 4% to 6% annual organic growth where we delivered 30 to 80 basis points of margin expansion and double-digit earnings-per-share growth, which we expect to deliver over a full market cycle. As Heath and I recap 2018, you’re going to see a strong results that were well ahead of this business model on all fronts. On the sales front, margin front, earnings-per-share growth, as well as capital generation and deployment.

When we talk about 2019 and over the past three months, we have seen changes in the macro environment and our guidance for 2019 does reflects lower growth in certain end markets that we’ll highlight during this call. While this may cause 2019 to be slightly below our target business model, I want to make sure you do know we remain committed and are going to accelerate the leverage we talk about that are under our control to ensure we improved financial performance as we move through 2019.

So, let me look back now 2018 a little bit before I get into the slides. And I’m very proud of our results. I think the results show the power of our strategy, as well as the execution of our teams. Some of the things I want to highlight before we jump into slide three is on the significant progress we feel we’ve made this past year in creating long-term value for our owners.

First of all, as Sujal highlighted, we announced the sale of our SubCom business, which improves our portfolio by lowering our volatility, enhancing our long-term growth and margin profile and positioning TE for stronger returns on future investments. Also during 2018, the revenue growth we saw, which was 15% overall and 9% on an organic basis and 9% organically is $1 billion of organic revenue growth, I think demonstrates the performance that significantly ahead of growth in the markets we serve.

We entered this year expecting 4% organic growth and our strong outperformance this past year once again reinforces the secular compact trends that drive our results and business model. We saw this illustrate among many of our markets, including auto, commercial transportation, sensors, factory automation as well as appliances. On the earnings front, first adjusted operating margins expanded up 100 basis point with increases in each of our three segments, and the expansion being driven primarily by our industrial communications segments which we talked to you about as a key drivers for more than an expansion over many years now and we saw the results here in ’18.

On an earnings per share, we grew 26%, which represents strong performance versus our industrial technology peers. And lastly about business model, it is the cash generation that I know we all like and we generated $1.4 billion in free cash flow this past year and expanded return on invested capital by over 150 basis points, which reflects both our discipline and balanced capital strategy. So I do have confidence that our portfolio is well positioned to continue to generate growth ahead in the end markets we serve as we go forward.

So let’s get into the slides, and we’re going to start with slide three, I’m going to jump back a little bit to just talk about the fourth quarter. And as we talk about the fourth quarter, as Sujal said, in continuing operations, which excludes SubCom, we delivered another quarter of above market performance with growth in all businesses. Sales were slightly ahead of our expectations at $3.5 billion and this represented 9% reported growth and 8% organic growth year-over-year.

In transportation, we grew 8% organically, well above our markets with growth in each of the segments three businesses. Industrial Solutions grew 6% organically with growth across all businesses. And our Communications segment grew 12% organically with strong growth in both data and devices and appliances.

Orders were up 4% organically, with growth in each segment, but we did see our orders declined sequentially by 8% and this reflects both return to more typical seasonality for business, as well as slower market environment in certain markets. In the fourth quarter, we delivered 17% adjusted operating margins, expanding 110 basis point year-over-year with margin expansion across all segments.

Adjusted earnings per share was $1.35 which was above our guidance and grew 19% versus the prior year, driven entirely by operational performance. In fact, currency exchange and tax rates were actually a headwind to our results in the quarter. Free cash flow was very strong at $670 million and we returned over $500 million to our shareholders through both dividends and share repurchases.

So if you could please turn to slide four, let me jump back to the full year briefing and then also talk about our guidance for ’19. For the full year 2018, our sales were $14 billion, up 15% on a reported basis and 9% organically. Transportation grew 11% organically, with 8% organic growth in Auto versus the global Auto production growth at less than 1% and this demonstrates the outperformance versus the market due to content growth trends, as well as our strong global position.

Industrial solutions grew 6% organically with growth across all businesses and benefits from content growth, and our Communications segment grew 11% organically with double-digit growth in both appliances and our data and devices unit. For the full year, our adjusted operating margins were up 100 basis points to 17.7%, but I do want to note that we exited the year at a 17% margin run rate, which represents a level of profitability that reflects a moderating macro environment. We delivered adjusted earnings per share of $5.61, which was up 26% over the prior year.

As we look forward, we are providing fiscal 2019 guidance for continuing operations for sales of $14.1 billion and adjusted earnings per share of $5.70 at the midpoint. This guidance represents 1% reported growth and 3% organic revenue growth and low single-digit EPS expansion. Our guidance reflects moderating order trends I’ll discuss on the next slide. But we do expect growth in each of our segments and performance of our margins driven by content growth. So, one big item is while we have 3% organic growth and that would equate to about $500 million of organic revenue, as we’ve been highlighting currency exchange effects are changing from being a tailwind last year to being a material headwind in ’19. And we expect currency exchange effects to negatively impact our revenue by $400 million.

Adjusted earnings per share includes a $0.30 combined headwind from currency effects, as well as the higher tax rate, that Heath will talk about. Without these headwinds, our EPS guidance would represent high single-digit growth worth not for these. While we can influence the market environment, we are going to execute on leverage we can control accelerated cost reduction plans of the first half and expand margins and EPS in the second half.

So let’s turn to slide five and let me get into the order trends that I’ve mentioned where we see the markets and we’ll get into it. Both, overall and by segment. So on slide five, as we discussed with you throughout 2018, we did have some markets that we’re running well ahead trend line, these include commercial transportation, factory automation and appliances. As we expected, we saw growth rates moderate from the first half to the second half of this year and expect these markets to continue to normalize in 2019. We did see global auto production fall to less than 1% in 2018 with 2% production declines in the fourth quarter. This is different than what we talked about 90 days ago.

Right now, we expect full year auto production to be flat in 2019 with first half production declining 2% year-over-year before improving in the second half. And offsetting some of this weakness we continue to see good momentum in our aerospace and defense, medical and data device and markets.

If you look at orders, on the slide, we saw 4% year-over-year growth on an organic basis. This was driven by growth in North America and Europe of 12% and 3% respectively, and this was partially offset by weakness in Asia, which declined by 2%. The slower growth rates we are seeing is reflected in the sequential decline that you see on the page and orders from quarter three to quarter four of 8%. We have been running book-to-bill ratio above — quite some time in this quarter book-to-bill of 0.99, reflects the slowing of the certain markets that I just mentioned earlier, and a return to more normal seasonal pattern for our business.

And just a reminder, since we haven’t experienced these normal seasonal patterns in a while, we typically see mid-single digit revenue declines sequentially from quarter four to quarter one, followed by sequential growth in quarter two an additional growth in the second half and that’s in line with how we’re guiding.

Looking at order by segments. Transportation organic orders were up 4% with growth in automotive and in sensors. Industrial orders grew 3% organically year-over-year with growth driven by aerospace, defense and marine, as well as medical applications. In communications, we saw a year-over-year organic order growth of 4% that was driven by the data and devices unit, partially offset by declines in appliances and our guidance for revenue growth reflects trends we’re seeing.

So let me get into our results by segment and if you could please turn to slide six, we’ll start with Transportation. Transportation sales grew 8% organically year-over-year with strong growth in each of our three businesses. Our auto sales were 6% organically and an auto production environment that declined 2% in the quarter, again reinforcing our ability to outperform the end market due to secular comp and growth trends. When we look at the quarter, we had solid growth in the Americas and China, while Europe was flat as customers were impacted by the WLTP implementation.

In commercial transportation, we continue to outperform the market with organic revenue growth of 15% year-over-year and double-digit growth across all regions and sub markets, but we have seen those orders reduce off from where we just had revenue.

Our sensors business grew very nicely 10% year-over-year with growth across auto, commercial transportation, as well as industrial applications. In the order sensor space we generated over $800 million of new design wins in 2018 and this brings our total design win value to over $2 billion since the beginning of 2016, across a broad spectrum of auto sensor technologies, as well as applications.

For the segment adjusted operating margins expanded 40 basis points year-over-year to 18.1%, as we’ve indicated, we have increased investment to support strong pipeline of new design wins, including those in the electric vehicle and autonomous driving applications. At the same time, we have seen production slow in both China and Europe causing a near-term correction and supply chain that has impacted mortgage for our business. We will balance near-term margin performance with long-term growth opportunities and are committed to getting margins back to our target level of around 20% in the second half of ’19.

Excuse me, so if we could move to the Industrial Solutions. Please turn on to slide 7 in the deck. The segment sales grew 6% organically, year-over-year to $1.1 billion with contribution from all businesses. In industrial equipment, organic growth was 4% led by strength in medical applications and a slower growth factory automation environment. Our AD&M business delivered 9% organic growth with growth across all businesses and particularly strength in Comair (ph). And our energy business grew 8% on an organic basis with growth in all regions.

When we look at the industrial space, we are continuing to see sustained momentum across a broad set of end markets. On the margin side on the segment, adjusted operating margins expanded a very strong 160 basis points year-over-year to 15% with operating leverage on the higher revenue. As we outlined earlier this year, we are on a multi-year journey to optimize our factory footprint and reduce expenses to expand adjusted operating margins into the high teens.

Our plans are on track as you could see in the fourth quarter and we expect fiscal ‘ 19 to be a year of heavy lifting, as we increase some investments to support factory consolidation activities, leading to nominal margin expansion for this coming year. And this is consistent with the plan that we’ve been outlining to you to expand long-term operating margins in the segment.

So let’s turn to communications and that’s on slide 8. During the quarter communication grew 12% organically, with data and devices and appliances delivering another quarter of very strong results and it’s nice that you get to see the true progress that our team has made in this segment without the volatility of SubCom. In data and devices, we grew at 17% organically with growth across all regions driven by high-speed connectivity and data center applications and content growth from electronification trends. Our appliance businesses grew 5% organically with growth in all regions as we continue to benefit from our leading global position.

Adjusted operating margins were 16.8% in the quarter and expanded over 300 basis points from the prior year. Four communication segment going forward, we are targeting a long-term model low to mid single-digit organic revenue growth with mid to high-teen operating margins.

Before I get into guidance a little bit later, I do want to turn it over to Heath, who’ll cover the financials for the fourth quarter, as well as for the full year.

Heath MittsExecutive Vice President and Chief Financial Officer

Thank you, Terrence and good morning, everyone. Please turn to slide 9, where I will provide more details on the Q4 financials. Adjusted operating income was $597 million with an adjusted operating margin of 17% and 110 basis points of margin expansion, driven by the strong 8% organic growth in the quarter. GAAP operating income was 570 million and included $22 million of restructuring and other charges and $5 million of acquisition charges. For the full year restructuring charges were $140 million and I expect another year at this level, as we continue to execute on optimizing the industrial footprint that Terrence mentioned earlier in improving the cost structure of the organization.

Adjusted EPS was $135 million, up by very strong 19% year-over-year, driven by sales growth in operating margin improvement in all segments. GAAP EPS was $4.78 for the quarter and included a tax benefit related to utilization of net operating loss carry forwards. This benefit was partially offset by restructuring, acquisitions and other charges of $0.06.

We ended 2018 with an adjusted effective tax rate of 17.1% for the year versus our long-term model of 19% to 20%. As we look ahead to 2019, I expect a more normalized effective tax rate at the low end of this range, so closer to 19%. This results in a tax headwinds of approximately $0.14 in our 2019 guidance compared to our 2018 results.

If we turn to slide 10. Adjusted gross margin expanded 70 basis points in the quarter to 33.7, with improvement from prior year, driven primarily by fall through on increased volumes. Adjusted operating margins were up 110 basis points year-over-year to 17% with strong organic growth driving leverage in the operating structure of the company.

We are proud of the expansion as across all our segments in Q4 and for the full year. Adjusted EBITDA margins also expanded year-on-year to approximately 22% in the fourth quarter. In the quarter, cash from operations was $922 million and up 10% year-over-year. Free cash flow was $670 million and we returned $570 million to shareholders through dividends and share repurchases in the quarter. For the full year free cash flow was 1.4 billion and included a step up in capital investments to support the rich pipeline of organic opportunities that I have discussed with you over the past year.

This CapEx investment is to support growth as we have mentioned before, has the highest return on investment for the company, which is contributing to the — over a 100 — 150 basis points of improvement in an adjusted ROIC this year to 15%. We continue to target mid teens adjusted ROIC as we balanced organic investments with acquisition opportunities. In fiscal 2018, we returned $1.6 billion to shareholders through dividends and share repurchases and used $153 million for acquisitions.

Our balance sheet is healthy and we expect cash flow to remain strong, which provides us the ability to support both return to our shareholders and acquisitions over the long-term. Given where we are trading our valuation is attractive. We will take advantage of this opportunity and balance share repurchases with acquisitions that arise this coming year. Also, as we’ve mentioned before, we are committed to returning the proceeds from the SubCom divestiture to our shareholders and in addition to buybacks from the normal share repurchase program.

Please turn to slide 11, to summarize our financial performance for the full year and illustrate the progress that we’ve made in each of our segments over the past two years, as we execute on our strategy. As Terrence mentioned our performance was ahead of our business model in 2018, with 9% organic growth and 100 basis points of adjusted operating margin expansion. This included double-digit organic growth in both transportation and communication segments.

When we have margin expansion in all segments, I’m very proud performance of our industrial and communication segments, as we execute on the levers to improve the operating performance of these segments. The Industrial segment benefited from volume leverage this year and it’s making great progress on their margin expansion goals. In communications, our results reflect the heavy lifting that our team did restructure and reposition the data and device business over the past several years. We expect to apply the same process to our industrial segment to drive margins to the high-teens.

In transportation, our 2018 growth was well ahead of our initial expectations, and while this is great for sales and earnings generation, we did experience operational growing pains, which unfavorably impacted the transportation markets. Fortunately, we feel that these growing pains are well understood and have been taking actions to improve the efficiency of our operations within the segment. And as Terrence mentioned as we progressed in 2019, our expectation is that the transportation margin gets back closer to our target margin rate. We continue to have significant growth opportunities in the transportation segment, we will continue to fund these investments while also balancing the operational improvement in the financial results.

I will — with that, I will turn back over to Terrence to cover guidance.

Terrence CurtinChief Executive Officer

Thanks, Heath, and let me get into guidance. I know I talked a little bit about at the lunch, quick down on 11 (ph) and if we can start on slide 12, let’s start with the first quarter. We expect first quarter revenue of $3.33 billion to $3.43 billion, an adjusted earnings per share of $1.25 to $1.29. At the midpoint, this represents reported sales growth of 1% and organic sales growth of 3%. And adjusted EPS expect to be down from the prior year first quarter. Given the recent strengthening of the US dollar, we expect the year-over-year currency exchange headwind in the first quarter of approximately $75 million and $0.04 in the quarter.

Because of the number of dynamics in quarter one on a year-over-year compare basis, I think it makes more sense that we’ve referenced back to the quarter, we just ended as a baseline when looking at our quarter four — quarter one expected performance. Our outlook for the first quarter of this year reflects the business returning to normal seasonal patterns that I discussed earlier, combined with a slower growth in certain end markets.

Our revenue guidance implies a 4% sequential decline at quarter on and quarter four, which is in line with the mid-single digit declines that we would typically expect. We expect operating margins to be slightly lower quarter four levels of 17%, as we adjusted solar market environment. However, we expect the margin expansion from the first half to the second half, driven by leverage that we control, resulting in a full year adjusted operating margin expansion from the 17% exit level in 2018.

Talking by segments in the first quarter. We expect Transportation Solutions to be up low-single digits organically. Auto revenue is expected to be at low digits organically versus the global decline in auto production of 2% driven by weakness in production in Europe and China. Our outperformance versus the market again reinforces the balance that we drive for content growth. Industrial solutions is expected to grow mid-single digits organically with growths across all businesses. And we expect communications to be up single digits organically driven primarily by data and devices.

So let’s move to the full year of ’19 and if you can move to slide 13, I’d appreciate it. As I said earlier, we expect full year revenue of $13.9 billion to $14.3 billion, which represents reported sales growth of 1% and organic sales growth of 3% at the midpoint. Once again, when you think about the top line going from where we just ended, it’s about $500 million of organic sales growth, offset by $400 million of currency headwind at the midpoint,.

Adjusted earnings per share is expected to be in the range of $5.60 to $5.80. We have the two headwinds both in currency and tax that both Heath and I talked about. But without those headwinds, adjusted earnings per share would be growing at a high-single digit rate at the midpoint and without those settlements, it’ll be closer to $6.

So let me provide some color on the segments on the full year, how we’re seeing it from a market and the revenue perspective. We do expect our Transportation Solutions segment to be up mid-single digit organically. Content gains are expected to drive mid-single digit organic growths in auto even in a flat global auto production environment that we assume for 2019.

We are expecting high-single digit organic growth in sensors driven by the ramp up of new auto design wins that we discussed earlier. In Industrial Solutions, we expect to grow low single digits for the organically with growth and aerospace, defense and medical being offset partially by slower growth in Factory Automation. And in communications, we expect it to be up low-single digit for the organically, driven primarily by our data and devices business.

So before we go to questions, I just want to recap some of the key takeaways from today’s call. We delivered exceptional results in 2018 across whole leverage of our business model, and I think we demonstrated the positive impact of the portfolio changes we’ve made and the benefit from the global secular trends that are going to consistently drive growth ahead of markets we serve.

As we move into the ’19, we are a slower growth environment, which we have reflected in our guidance and it’s also important that we remain committed to our long-term business model and we do have levers to respond to the market conditions and you’ll see it in the first half to second half margin expansion and EPS expansion that’s included in our guidance. And as always, we all appreciate the strong cash generation model that we have and we’re going to continue to maintain our balanced capital strategy to make sure we’re driving value creation progress. So as I close, I guess I just want to thank our employees across the world for their execution through 2018, as well as our commitment as we go into 2019 to both our customers, and our owners. And as we create a future, that safer, sustainable, productive and connective.

So Sujal, with that let’s open it up for questions.

Sujal ShahVice President of Investor Relations

Okay. Thanks, Kelly. Could you please read the instructions for the Q&A session.

Questions and Answers:

Operator

(Operator Instructions) Our first question will come from the line of Amit Daryanani of RBC Capital Markets. Please go ahead.

Amit DaryananiRBC Capital Markets — Analyst

Thanks a lot guys. Terence, given your expectations for auto production for the full year being flat. How do you think China is going to start-up within those expectations? And how are you dealing with the potential China stimulus I guess helping you guys over fiscal ’19, if that’s only baked into your guide or not? Thank you.

Terrence CurtinChief Executive Officer

Thanks, Amit. Let me get into the geographies as we see them and that’s assumed our flat auto production environment. It is something versus 90 days ago, 90 days ago, we would have told you — we would have thought auto production in ’19 would be similar to what we were experiencing in ’18 which 1% to 2% and it did turn flat based upon some of the dynamics we’re seeing. By region as we look at next year in that flat environment, it’s really North America continues to be in the continued flat environment, it’s been — we see Europe being slightly down and we actually see Asia being slightly up. And that does include what we believe the stimulus that the Chinese government looks like they’re going to put in here, beginning in January on the smaller sized combustion engines.

So when we look at our flat next year, I think we’re going have Europe slightly down, North America flat, Asia driven mainly by China being slightly up,

Sujal ShahVice President of Investor Relations

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

Operator

We’ll go to the line of Christopher Glynn with Oppenheimer.

Christopher GlynnOppenheimer and Company Inc. — Analyst

Yeah, thanks. Just wanted to ask about the free cash flow outlook and how to think about conversion, the 70% plus conversion was a little late this — in ’18. CFO was clearly good. But as we look into next year, just wondering on the swings, where does CapEx go, as working capital kind of an opportunity on the slower growth?

Heath MittsExecutive Vice President and Chief Financial Officer

Sure, Chris. This is Heath. I think, if you think about our cash flow for 2018, a couple of things you have to take in consideration; one, we consciously took up our CapEx year-over-year to take advantage of some very attractive growth opportunities, particularly in the transportation segment, that’s across the board both auto, commercial transportation, as well as sensors. And many times in this market you’ve got to invest in some things if you want to program, maybe after two years in advance of when you’d actually see the revenue. So that’s a — if I was looking at our CapEx that’s a good indicator on our confidence toward our revenue pipeline there.

The other thing is, obviously, we did eat through with the type of organic revenue growth that we’re talking about for the year nearing double digits, we did use some working capital. As you think forward into 2019, slower growth that working capital, much of it’s going to come back into cash flow out of inventories and receivables. And then from a CapEx perspective, I would say, it will moderate some from what we spent this past year, but it’s still going to be somewhere in that 800 range of CapEx.

Sujal ShahVice President of Investor Relations

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

Operator

We’ll go next to the line of Wamsi Mohan of Bank of America Merrill Lynch.

Wamsi MohanBank of America Merrill Lynch — Analyst

Yes. Thank you, good morning. I was hoping Terrence, you can talk a little bit about the linearity this year, given the fact that you’re starting off with this assumption of 2% decline in auto production and ending for the full year at flat. How should we think about the seasonality different this year relative to let’s say last year? And Heath perhaps you could address like what specific steps you’re taking to accelerate cost savings here? And how we should expect that profitability, linearity also to progress through the course of the year? Thank you.

Terrence CurtinChief Executive Officer

Thanks, Wamsi for the question. Let me talk a little about the seasonality because it’s something — in the environment, I think, all of us have had for the past couple of years. In some cases, our seasonality hasn’t been typical. But, when you look at our guidance and even when you see the orders, orders did grow during the quarter, certainly at a slower rate than we’ve seen. We saw the sequential decline, that I mentioned. And that is pretty typical for our business. And so, when we look at our guidance for this year, we are pretty guiding at historical seasonality, which is the first quarter comes down a bit of the force, you get a little bit more growth in the second and then certainly the third, it is typically our strongest and then a little bit of moderation into the four.

So our guide as we look at where orders were, does show a more natural shape. Form the standpoint of clearly, and it goes all the way to Amit’s question, when you have an environment that goes from 2% growth to declining a little bit like in auto, you’re going to get a little bit of supply chain movement that we are dealing with that’s reflected in our guidance, but I’ll let Heath talk a little bit about what we’re going to do for lending on the profitability side.

Heath MittsExecutive Vice President and Chief Financial Officer

Sure. And Wamsi, I appreciate the question. As couple of things that we’ve talked about in the past, which we described and continue to describe as a multi-year journey, so more specifically, that’s our industrial footprint optimization and that’s not, we’ve been well under way with that as we worked our way through 2018 and certainly in a more aggressively in 2019.

I would say from a segment perspective, some of the bigger actions that were taken in ’19 in the industrial footprint will see a much more significant margin rate improvement as we get into actual 2020. This is kind of a year internally that we said a year of execution for our industrial team as there is a couple of very large sites that are coming offline. And as that happens, those are not things that happen overnight, so this has been in progress for a while. I think we’ll see is modest or flat margins in our industrial segment in 2019. And as we’re going to — as we exit the year you would expect some significant improvement there.

The other thing we got to take a look at is we just sold a business roughly $700 million of revenue. That does create an element of stranded costs that we have to address in our structure. And that does put near-term pressure on our margins, as we pull out that amount of revenue without that amount of cost.

So we’ll be addressing that, we’ve already begun taking those steps and we’ll continue to do so through the first part of this year. So you would expect our second half margins in aggregate for the company to be higher than the first half as we tackle these things.

Sujal ShahVice President of Investor Relations

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

Operator

We’ll go to the line of Craig Hettenbach with Morgan Stanley.

Craig HettenbachMorgan Stanley — Analyst

Yes, thank you. (Technical difficulty)

Sujal ShahVice President of Investor Relations

I’m sorry about that. We’re going to go to the next question please. And Craig, we had a bad connection, we will come back to.

Operator

We’ll go to the line of Joe Giordano with Cowen. Please go ahead.

Joseph GiordanoCowen and Company — Analyst

Hey guys. Good morning.

Terrence CurtinChief Executive Officer

Hey, Joe. Good morning.

Joseph GiordanoCowen and Company — Analyst

So can we go through kind of what you’re seeing in the supply chain. I know Heath, we talked last like on a year-on-year in auto last year, it was a headwind, I think it was like 150 basis points from kind of supply chain inflation and some stuff yet to do on the logistics side to expedite. Could we talk about what we’re seeing now? Is it — is that kind of pressure accelerating, moderating a little bit and implications on auto margins there?

Heath MittsExecutive Vice President and Chief Financial Officer

Sure. I think when we think about supply chain, there is a couple of pieces here. I’m going to tackle the first half and then I what Terrence to grab the second. When we — certainly things that we have dealt with relative to our operational matters involve our supply chain and availability of parts should be around the good things, and then through our factories and the cost to expedite some of that. Much of that is behind us or we’re on the better end of that journey in terms of the pain points that has cost. Albeit, we’re not — we’re never going to let our customers down in terms of being a critical component of their supply chain, and so we, at times have to do things that drive in efficiencies in our factories to make sure we get out and some of the capital that we’ve spent this year, in addition to the growth programs has gone to address those types of matters.

I feel that we’ve right into that journey. But again you’ll continue to see margins march-up as we progress in — as we progress through the year. And then relative to supply chain and some of our prepared remarks, that is causing some air pockets in our demand for sales of what — Terrence go on please.

Terrence CurtinChief Executive Officer

Yeah. Certainly Joe on the other part there. We have seen in certain markets, customers get conservative and inventory levels. While we see things like POS staying in this moderating growth environment. We have due to some of the inflationary pressures of seeing elsewhere, as well as I think some of the tariff effects actually cause a little bit. So we are seeing that as part of our moderation, it’s very different depending on the market dynamics. Markets that are on top, we don’t see it, markets that are moderating a little bit we are seeing some positives in the supply chain and the purchasing activity that we see. As typical, those type of facts work through in three, four months and we do see it in certain markets right now.

Sujal ShahVice President of Investor Relations

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

Operator

We’ll go to the line of Shawn Harrison of Longbow Research. Please go ahead. Mr Harrison, your line is open. If you have your mute button ON please take it off or pickup the handset.

Shawn HarrisonLongbow Research — Analyst

Hi, good morning all. This is probably the last time ever you’ll have this question. But SubCom, what was previously the embedded earnings forecast for that business in 2019 prior to the sale? And do you anticipate through buyback and cost reduction actions that you’ll be able to fully offset any dilution from that sale?

Heath MittsExecutive Vice President and Chief Financial Officer

Well, Shawn, this is Heath. We didn’t get into disclosing, given where we were in the process internally, what the impact would been for our ’19 numbers because we had a pretty good indication early on during our budget process, where it was going to fall out. So to try to put it in a ’19 number on there would be somewhat speculation at this point. In terms of the dilutive impact, obviously it did not have a material amount of profitability as you review the numbers that we disclosed in the 8-K that was sent out earlier today, you’ll see that there was not much profitability in that business in our fiscal ‘ 18 numbers.

So from that perspective, which was obviously a number that was — had been, we worked through the quality issue with one of our contracts and that had certainly an unfavorable impact to the businesses, overall margins. But as we think through more of a normalized piece for SubCom relative to the price that we got in the shares, we’re going to purchase back I would say that year-over-year perspective, you’ll see a very moderate amount of dilution, and you’ll see — and obviously when we normalize the numbers and uptick gross margins and our overall operating income.

Sujal ShahVice President of Investor Relations

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

Operator

We’ll go to the line of Matthew Sheerin Sheerin with Stifel.

Alvin ParkStifel — Analyst

Yes, hi, this is Alven Park on behalf of Matt Sheerin.

Terrence CurtinChief Executive Officer

Hey, Alvin.

Alvin ParkStifel — Analyst

Hi, hello. And just in terms of the content spread with the auto production growth, the quarter had 8% organic growth in transportation on a 2% decline, implying a spread of roughly 10 points. Just wondering how management is viewing that spread come fiscal year ’19 and if that large spread cadence can be maintained or if you see a compression, just any color on that?

Terrence CurtinChief Executive Officer

A couple of things, let’s go back to what we believe that spread should be, in that spread and like we said in our Investor Day is that mid-single digit spread both from the trends we get around electronification content change due to both, what happened to electric vehicle as well as autonomy and the connected car. So that spread does not change, this past year, certainly our performance was well ahead of that. But as we look at next year in a flat environment, we believe our auto business will grow mid-single digits, right at that content — that we’ve always said.

On a quarter or a period, you will get programs that make it and move move out. But long-term that four to six and mid-to-single digit content is what we expect based upon the program for seeing — to drive up to the content per vehicle, we’ve always talked to owners about. So, while we may have a little bit of a supply chain effect in quarter one, we feel very good at in a flat environment, we’re going to grow that mid-single digit, where we guided for the year.

Sujal ShahVice President of Investor Relations

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

Operator

Okay. We’re going to go back and try Craig Hettenbach’s line again from Morgan Stanley.

Craig HettenbachMorgan Stanley — Analyst

Hello, thanks. Sorry it was some line issues. So Terrence, just a question on the sensor when you called out $800 million in fiscal ’18 . Can you talk about in areas where you’re winning kind of where you’re differentiating versus the competition? And then as part of that I know the company has talked about kind of leveraging the core connector technology with sensors and what type of traction you’re seeing there as a go to market with oil OEMs?

Terrence CurtinChief Executive Officer

Sure. Thanks, Craig. And so, first off, we talked about the wins that I mentioned in the call. You see the momentum we’ve continue to have, and those sensor wins over $2 billion. And you’ve also seen, we’re starting to see the growth on the auto programs, that we’ve always told you, when we went on the auto program, it takes years for that to actually launch. And you’re seeing that we continue that momentum there and now help the growth where we guided in sensors next year.

When we bought this, it was always around how do you take the great product bag and technology bag they have and really get it focused on vertical applications. And our first approach was very much around where we leveraged these and the transportation space. And I think that’s what you see, it is very broad, the sensor space is a very broad space, it is a space where there is internal divisions we compete against with, some small company, certainly some larger companies. And our wins we’re competing against that fragmented space.

What I would say from an application, the application we feel very fortunate because we’re starting a little bit from clean slate since Meas didn’t have much automotive business and I think we’re really driving wins where they’re differentiated and whether that or things around electric vehicles, certainly around humidity, temperature, pressure, it’s a very broad base that we feel good about, we’re going to continue to leverage it.

We’re also looking where other verticals that we should be looking at sensors knack (ph), I would say that’s still how do we scale that, it’s still some of the opportunity we have as a company. And — but early at the gate it was very much transportation focused.

Sujal ShahVice President of Investor Relations

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

Operator

We’ll go to line of Jim Suva with Citi.

Jim SuvaCitigroup — Analyst

Thank you very much. And thus far you’ve provided great details. One follow-up I have is, in your prepared comments you mentioned about right-sizing and realigning some of the businesses. As we look into the 2019 and looking at your reporting lines of businesses, where can we see the most focus for that right lining of those businesses maybe by segment about where the most effort will be? And is it kind of a near-term pressure pause on the margins of those businesses before they get better?

And is it all internally planned or is it also driven by some of the political items that are going on with the tariffs, adding to that or would that be incremental depending upon how that all sources sort out? Thank you very much.

Terrence CurtinChief Executive Officer

Jim Suva, I appreciate the question. But my perspective in terms of where were our efforts and focuses are. Certainly, what we’ve talked about relative to the Industrial segment is unchanged. We have been undertaking, we continue to undertake some footprint consolidation activities. We will in 2019 because there’s some investments that get made as we do, we run in parallel as things move to different regions and things like that. You won’t see a ton of margin expansions that probably guide you to model it roughly flat year-over-year at the segment level.

With an expectation that as we exit the year, you’ll start to see this tick up as some of the bigger cost locations come offline. So that’s organized effort largely the team that right-sized our data device business over the last several years, that same team is now involved in industrial segment and they are well under way in terms of what they’ve been working on toward that goal.

As we think about transportation, I think what you’ll see is, you’ll see where we exited this year with transportation in terms of 2018, there are certain lease in activities in place to make sure that we are sized correctly, as well as in the right areas. My expectation is that you’ll continue to see the margins tick up as we move from quarter-to-quarter sequentially and certainly from the first half to second half and realize the benefit of some of those actions that are under way.

While we’re still investing in the growth profile of that business, because that business continues to have strong trends and nothing has changed from that perspective in terms of where we’re going within the transportation or whether it’s the sensors business that Terrence has talked about, we’re certainly in commercial transportation and auto that are benefiting from the trends of electronification of vehicles. So there’ll be a balance there, but as you model the year, you should expect margins to tick up sequentially as well as, certainly first half, second half.

And then communications right? Now communications is a business that certainly from a margin perspective has finished 2018 very strong. The data device business and appliance businesses, which are the only to be used left in that segment, right? They’re both doing well, you’ll see more growth in data and devices this year and then appliances, I think you’ll see a little bit slower growth because we’ve come to enjoy our outsized growth relative to those in markets, but you’ll still numbers there. From a margin rate perspective, this is little bit less about restructuring more about growth, from where our focal points are — but no, that’s just a lot of small numbers, you could see some volatility quarter-to-quarter within that segment as any one quarter could have better mix in another quarter and so forth and you don’t have quite the amount of variability in there, that — may be once had. So just keep an eye on that. But if you want to guide mid to high teens for that segment, I think that’s a fair place.

Sujal ShahVice President of Investor Relations

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

Operator

We’ll go to the line of Mark Delaney of Goldman Sachs.

Mark DelaneyGoldman Sachs — Analyst

Yes, good morning. Thanks for taking the question.

Terrence CurtinChief Executive Officer

Hey, Mark.

Mark DelaneyGoldman Sachs — Analyst

I was hoping to talk more about commercial transportation specifically in the commentary about some slowing in orders as you exited the fiscal year. Was that a broader based comment or was that more specific to China? And then just maybe remind us how much of the commercial transportation businesses China exposed?

Terrence CurtinChief Executive Officer

No, I think when you look at our commercial transportation business, we’ve had tremendous growth the past couple of years there. And a lot of it has been driven by the truck market in China. And it’s been both market benefit, as well as the content benefit, about half of our growth over the past couple of years has been content driven. And I think it’s what our team has done, that have been very pleased with. What we have seen is certainly China from a truck perspective, we do expect that to be down. So we are going to get impacted to that, as well as the supply chain affects that go with that.

So China is a big driver of it, that drives that overall market, with where it has shifted. If you look at that business today, that business today is about 30% in China, the rest of it would be in the West between Europe and Americas. So I think it’s one of the things that was a much smaller penetration for us historically, I think it’s a real success. And a lot of content win there, but the market is — we see some market changes there.

Sujal ShahVice President of Investor Relations

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

Operator

We’ll go to the line of Deepa Raghavan of Wells Fargo Securities.

Deepa RaghavanWells Fargo Securities, LLC — Analyst

Good morning.

Terrence CurtinChief Executive Officer

Good morning, Deepa.

Deepa RaghavanWells Fargo Securities, LLC — Analyst

Wanted to talk about free cash flow a little bit more in detail. Just given all the cash — all the incremental cost actions that you are taking. Would that be a little bit more of a headwind to free cash flow into ’19? And the second part to that is, I don’t know the cash profile of your SubCom business, just curious how does your free cash flow settle for ’19, just given your incremental cost actions and your SubCom exit? Thank you.

Terrence CurtinChief Executive Officer

Thank you, Deepa. Good question. So, relative to the amount of restructuring cash, as I mentioned, we guided throughout 2018 that we — that our — that the P&L impact on restructuring to be about $150 million. You can assume about 75% of that was real cash versus, I’ll say, non-cash charges inside there. We ended the year about $140 million, I would tell you that for modeling I think $150 million is probably a good number as we think about it. As we progress through the year, we’ll keep everyone updated if that number changes and we update our forecast relative to that. But I don’t see a relative to how we thought about the cash flow impact of the restructuring in 2019 to have a material difference from how it impacted us in ’18 from a cash perspective.

The biggest benefit we’re going to get from cash perspective is certainly working capital back off on seasonality that, so I’ll say more moderate growth rates versus the organic trends that we had been at. And then we’ll have a better, a more significant impact driving our cash higher. As we think about SubCom, SubCom is a business that at times a very lumpy cash flow, so the cash flow in that business did not always follow necessarily where revenue and profit followed in that business just by the nature of that when you receive progress payments and money that was received upfront from time to time, as well as when projects were commissioned, you might receive a windfall toward the back end of a project.

So, it was very lumpy as we think about that business in 2018 relative to ’19, obviously we’ve pulled those numbers out from a discontinued operations perspective. But not going to have a significant impact from how I would think about cash conversion.

Sujal ShahVice President of Investor Relations

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

Operator

We’ll go to the line of Steven Fox with Cross Research. Sir, your line is open.

Steven B. FoxCross Research — Analyst

Yeah. Sorry about that. Good morning.

Terrence CurtinChief Executive Officer

Hey, Steve.

Steven B. FoxCross Research — Analyst

Hi. So a couple of questions from me please. First of all, obviously there’s been a pretty sizable change in your — in the industry’s outlook for auto production. It sounds like some of it is actually related to some spot plant shutdowns. So, I’m trying to understand like the risks between now and the end of the year that you see maybe some more unexpected plant shutdowns, how much of that is already factored into your guidance? And then how you would deal with sort of that to avoid extra inefficiencies? And then I had a follow-up.

Terrence CurtinChief Executive Officer

Well, Steve. First off, we’ve taken the data that we see here from our customer interactions as well as, where do we see order forecast. So we have all of that, that when you look at here you sort of say before the end of the year, I’m assuming calendar year. We get orders from our customers, because it is just in time industry that’s there. So feel that what we gone out with, reflects of shutdown, certainly, that we saw some of it taking advantage of Europe specifically and that was also the WLTP, which I think is less around Europe shutdowns, but certainly regulation and I think everybody trying to catch up on. So, I feel that where we’ve guided, reflects the areas that we’ve heard from our customers.

And what we’ve been doing as Heath mentioned is there are areas, when you get an adjustment like that, we have to adjust our operations for, and that’s what we’re doing across auto and it is, so business is going to grow 5% mid-single digit next year in a flat environment. So when we look at it, we have to adjust from running at 10% like we had almost this year bound to about half of that growth and that’s what we’re working through right now.

Operator

We’ll go next to the line of William Stein with SunTrust.

William SteinSunTrust Robinson Humphrey — Analyst

Hey, thanks for taking my question.

Terrence CurtinChief Executive Officer

Hey, Will.

William SteinSunTrust Robinson Humphrey — Analyst

Hi. The last time we had a meaningful slowdown in automotive that is the credit crisis and I’m certainly not saying that’s what unraveling today. But during that time, we saw a pretty significant inventory reduction across the supply chain that triggered meaningfully below unit growth for your transferred sales, despite the content growth story that was in full swing at that time as well. So it sounds like you think that the current environment is sort of a one-and-done pause quarter or maybe something like that, very short with very small. What gives you the confidence to guide that way for at least that out fields for the year? Thank you.

Terrence CurtinChief Executive Officer

So I think a couple of things, Will. So I think you have to again — we’re auto build a bit (ph) and some of it is last year’s first quarter was very strong. Will, I think with same moderation occurred here, adjusting, like we said a little bit in Europe, a little bit in China, North America has been flat for three years. So I don’t think we’ve been in an accelerating automotive environment, we’ve been in a decelerating auto production environment when it comes to growth for multi years now.

Certainly, we thought it was going to be more like 1% to 2% growth going into ’19. It’s a little bit sharper, that’s down to zero. So I do think auto production has been adjusting and from that view point we think it’s appropriate. When you look at auto production, we see it basically being about 24 million units the first three quarters and then actually go on to 22 like it normally does. So when we look at our flat, some of that’s related to compares of where do we see production and certainly there’s pauses in places like Europe, right now with WLTP and certainly China is adjusting. But, we expect Asia to have fluid single-digit growth, it’s nowhere close to the growth that had three, four years ago.

Sujal ShahVice President of Investor Relations

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

Operator

We have a follow-up from the line of Joe Giordano of Cowen.

Joseph GiordanoCowen and Company — Analyst

Hey guys. Thanks for taking the follow-up here.

Terrence CurtinChief Executive Officer

Hey, Joe.

Joseph GiordanoCowen and Company — Analyst

Just — I know you guys are generally pretty conservative in your guide. But let’s just say we do have a further deterioration in end market conditions and you guys do have a pretty high volume fixed cost base. Given the spending that you’re planning on doing to right size everything, How quickly could you tamper spending to kind of deal with the slower growth environment than you’re currently contemplating?

Terrence CurtinChief Executive Officer

Joe, I think it’s a fair question, certainly, we contemplate a lot of different scenarios as we put together these plans. And the teams rally around in terms of leverage that can be pulled, there are levers that we’re pulling now relative to just the overall softening of the general macro situation and everything we’ve talked about over the last hour. There will be additional levers that certainly we have queued up that, if things worsened and you would expect us to pull those.

So how quickly can we pull them? Well, pretty quickly. We have — this wouldn’t be starting from scratch, we’ve done the work and we take a look at it. But, no different than you would expect us to in preparing the company for various types of macro conditions. At the same time, we will balance out the growth, we’re not — these are businesses and we started talking about things like automotive, across the board and aerospace, and so forth that when you’re winning programs and inspect then to programs with our customers that sometimes you’re going to have to swallow hard in the near-term to be successful in the long-term.

And I think, if you look at our history of that even well before I got here, the company has done a good job of balancing that out to make sure that we keep our customers happy and that we don’t lose something because of short side. And so, there’ll be a balance, there is some self-help things that certainly, we will execute on and have been executing on and you’ll see those start to be reflected in the financial results. At the same time, there is a level of agility that we talk about internally, and that we have queued up to allow us to pull those levers when and if they happen.

Sujal ShahVice President of Investor Relations

Okay. Thank you, Joe. It looks like we have no further questions. So I want to thank everybody for joining us this morning. If you do have follow-up questions, please contact investorrelations@te. Thank you, and have a great day.

Operator

Thank you. And ladies and gentlemen, today’s conference will be available for replay after 10:30 AM Eastern Time today, running through midnight on Wednesday, November 7th. You may access AT&T replay system by dialing 1800-475-6701 and entering the access code of 454471. International participants may dial 320-365-3844. Those numbers again are 1800-475-6701 and 320-365-3844 with the access code of 454471.

That does conclude your conference for today. Thank you for your participation and for using the AT&T Executive Teleconference Service. You may now disconnect.

Duration: 62 minutes

Call participants:

Sujal ShahVice President of Investor Relations

Terrence CurtinChief Executive Officer

Heath MittsExecutive Vice President and Chief Financial Officer

Amit DaryananiRBC Capital Markets — Analyst

Christopher GlynnOppenheimer and Company Inc. — Analyst

Wamsi MohanBank of America Merrill Lynch — Analyst

Craig HettenbachMorgan Stanley — Analyst

Joseph GiordanoCowen and Company — Analyst

Shawn HarrisonLongbow Research — Analyst

Alvin ParkStifel — Analyst

Jim SuvaCitigroup — Analyst

Mark DelaneyGoldman Sachs — Analyst

Deepa RaghavanWells Fargo Securities, LLC — Analyst

Steven B. FoxCross Research — Analyst

William SteinSunTrust Robinson Humphrey — Analyst

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