TEL - NYSE

Ladies and gentlemen good morning, and thank you for standing by. Welcome to the TE Connectivity Third Quarter 2023 Earnings 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. And 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 third quarter 2023 results and outlook for our fourth quarter. 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. I also want to remind you that our Q4 results in fiscal 2022 included an extra week. In this call, year-over-year comparisons for the fourth quarter and fiscal 2023 are made excluding this extra week. 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.

Thanks, Sujal, and thank you everyone for joining us today. Before we get into the slides and as I typically do, I want to take a moment to discuss our performance this quarter, within the backdrop of the market environment, along with what we're seeing versus our last call, 90 days ago. I am pleased with the execution of our teams in the third quarter, with revenues that were in line and EPS that was ahead of our guidance, due to strong performance across all three segments. Our Transportation and Industrial segments grew year-over-year, which essentially offset the expected declines in our Communications segment. Our adjusted operating margins expanded 130 basis points sequentially, without the benefit of any volume growth. We delivered on the actions that we've been driving to ensure margin expansion occurred, as we move through this fiscal year. Also, as important, you're going to continue to see the benefits from the strategic positioning of our portfolio around secular growth trends, including increased global production of electric vehicles, adoption of renewable energy and applications for cloud and artificial intelligence. In the quarter, our orders of $4 billion are not only indicating stability in transportation and industrial, but also in our Communications segment as well. I view the older trends to be a real positive and they're reflecting the improving supply chains and reinforce our fourth quarter guidance, which I'll get into more details in a moment. As we've been sharing with you, one of the key areas of focus this year has been working capital management as supply chain performance improves. Our strong free cash flow performance reflects our focus, both in the quarter as well as you see it year-to-date. Cash generation is an important part of our business model and year-to-date free cash flow was up 40% versus last year. Also, our capital strategy continues to remain disciplined and we've returned roughly $1.2 billion of capital to our owners so far this year. Let me now provide some additional color on our markets and other updates since our last call. So, on an overall basis, our markets are playing out as we expected. We have most of our key end markets in a growth or recovery trajectory and we have a few markets that continue to cycle and these we previously discussed with you. Our view of transportation end markets remain consistent with our prior view and we continue to expect auto production to remain roughly flat at approximately 20 million units per quarter globally. Our growth in the transportation area will continue to be driven by content outperformance and our leading global position in electric vehicles. Turning to our Industrial segment. We have three businesses that continue to have strong growth momentum. You continue to see our strong positioning in renewable energy with growth from both wind and solar applications. In commercial air, sales continue to grow as this market recovers and our medical business is benefiting from increases in interventional procedures. In our communications segment, while sales are down significantly this year versus last year's cyclical peak, our order trends are indicating stabilization at the current levels. And finally, I do want to reinforce that the way we think about long-term value creation remains unchanged. It's 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 leverage to enable margin expansion as we move forward. While our orders are indicating stability, we continue to see strong opportunities to expand sales, margins and earnings per share as we move forward. So at this time I want to get into slides and we'll discuss some additional highlights. And if you could turn to slide 3, I'd appreciate it. Our third quarter sales were $4 billion and this was in line with our guidance and down slightly year-over-year on a reported and an organic basis. We saw organic growth of 7% in our Transportation segment and 2% in our Industrial segment. Our communications segment declined due to the expected market weakness that we've been talking to you about. Adjusted earnings per share was ahead of our guidance at $1.77 with adjusted operating margins of 17.3% and these margins were up 130 basis points sequentially as I already mentioned. The margin improvement from quarter two to quarter three was driven by our Transportation and Industrial segments as we are delivering on our commitment to expand margins from the first half to the second half of this year. Our earnings per share performance that was ahead of guidance was driven primarily by the stronger margin performance. As we look forward, we are expecting our fourth quarter sales to be approximately $4 billion and adjusted earnings per share to be around $1.75, which are both similar to our quarter three levels. Also similar to our third quarter we do expect year-over-year sales growth in our Transportation and Industrial segments and a decline in our Communications segment. Just moving away from the financials for a moment. I do want to highlight that we issued our corporate responsibility report, which we call connecting our world and we've issued this report for over a decade. There are a number of initiatives that we're driving internally and our goals are in line with our purpose as well as expectations from our customers. Key highlights in the report versus prior year includes an over 30% reduction in our absolute Scope 1 and 2 greenhouse gas emissions and currently I want to highlight that 50% of the electricity in TE comes from renewable sources. I also want to note that we communicated our commitment to the science-based target initiative, which enhanced targets for greenhouse gas reduction by 2030 that are inclusive of Scope 3 emissions. So with that as a quick background on slide 3 let's move to slide 4 and I want to talk about our order trends. On the slide you can see the details on the moving pieces, but I do think the key takeaway is that our orders are reflecting stability in all three of our segments. And this is nice to say after some of the order patterns we've had over the past couple of years. And these orders reflect and reinforce our guidance for the fourth quarter. When you look at our transportation and industrial orders they're both roughly flat from the second to third quarter. The real highlight in where you see the changes in our communications segment where orders increased 5% sequentially. And this is the first sequential increase in our Communications segment orders since the first quarter of fiscal 2022. So with that quick overview of orders, let me now discuss the year-over-year segment results that are laid out on slides 6 through 7 and you can see the details and I'll just talk about the high points. In our Transportation segment, sales growth remained strong and it was up 7% organically year-over-year with organic growth across all of our businesses. Our auto business grew 9% organically and we had growth in all the regions of the world. The strong performance continues to be driven by our leading position in electric vehicles as well as electronification trends in cars and positive impact from pricing. While auto production is staying flat at about 20 million units per quarter production of hybrid and electric vehicles are continuing to grow and right now reflect about 25% of total global auto production in our fiscal 2023. As you know we generate approximately two times the content in electric vehicle platforms versus a combustion vehicle. So, we expect our content per vehicle to continue to expand as we move forward and the increased adoption of electric vehicles. Elsewhere in this segment, our Commercial Transportation business we saw 2% organic growth in the third quarter and in our Sensors business our 4% organic growth was driven by automotive applications as we see increased volumes from new design wins. At the margin level, in the segment, adjusted operating margins were 18.6% in the quarter and this was up 130 basis points year-over-year and 200 basis points sequentially as a result of operational performance including the benefit of price increases. Now, let me move over to the Industrial segment. At the segment level sales increased 2% organically year-over-year, where we had strong organic growth in three out of the four businesses in the third quarter. In our AD&M business, our sales were up 13% organically and we're benefiting from the ongoing improvement in the commercial air market. In Medical, sales in the quarter were up 11% organically, driven by ongoing increases in interventional procedures. Turning to our Energy business. We continue to see momentum with 8% organic growth driven by renewable applications. The addressable market for TE and renewable applications has a double-digit CAGR and we're helping to enable utility scale solar and wind farm deployments. Through our broad product portfolio, we are helping our customers reduce installation as well as maintenance costs and we expect our sales from renewable applications to be up double-digits again this year. What's really nice in this business is that the current quarter continues to demonstrate the growth momentum that we've been delivering in this business, which has had an organic sales CAGR of 8% since 2019. And finally in the Industrial segment. In our Industrial Equipment business, our sales were down 10% organically and this sales decline was driven by inventory digestion in the distribution channel and is being driven by improvements in the broader supply chain that we're all feeling. In the Industrial segment adjusted operating margins were 15.8% and these margins reflect the impact of the expected volume declines in the Industrial Equipment business. And I want to highlight that we remain committed to achieving our high-teen margin target for this segment. Now, let me turn to the Communications segment and in this segment, our sales were down 37% organically to $424 million and it was slightly lower than we expected. Versus last year's cyclical peak, Appliances and our Data and Device businesses are being impacted by market weakness and the ongoing consumption of inventory across our customer supply chain that we previously discussed with you. Despite this weakness in sales we maintained adjusted operating margins in the mid-teens range at 14.2%. Based upon the order trends I talked about earlier we believe communications revenue will be roughly flat to quarter three levels in the fourth quarter with adjusted operating margins remaining in the mid-teens. Now, with the Communications segment, I do want to look beyond the near term for a moment and really talk about what we get excited about especially in our D&D business as it continues to have strong design win momentum in next-generation AI platforms. When you think about where we play we focus on providing the high-speed low latency connectivity to meet the needs of these next-generation data centers. Last quarter we mentioned that we secured $1 billion in wins for AI and certainly related server applications. And I just want to highlight for you this number continues to grow. We expect meaningful ramps of AI programs, as we move through fiscal 2024 with 50% more content in an accelerated compute AI platform versus a traditional compute server. The other key highlight is, we're working closely with cloud customers as well as leading semiconductor companies with reference design to call out our TE Connectivity solutions. So with that, as a wrap-up, let me turn it over to Heath, who will get more details on the financials as well as our expectations going forward.

Well, thank you Terrence and good morning everyone. Please turn to slide 8, where I will provide more details on the third quarter financials. Adjusted operating income was $692 million with an adjusted operating margin of 17.3%. GAAP operating income was $630 million and included $53 million of restructuring and other charges and $9 million of acquisition-related charges. Year-to-date we have taken $208 million of restructuring charges, and we continue to expect full year restructuring charges to be approximately $250 million, as we continue to optimize our manufacturing footprint and improve the cost structure of the organization. Adjusted EPS was $1.77 and GAAP EPS was $1.67 for the quarter and included restructuring and acquisition and other charges of $0.10. The adjusted effective tax rate was 18.2% in Q3. For the fourth quarter and for the full year we now expect our adjusted effective tax rate to be approximately 19%. Importantly, we continue to expect our cash tax rate to stay well below our adjusted ETR for the full year. We can get you to turn to slide 9. Sales of $4 billion were down 2% reported and 1% on an organic basis year-over-year. Currency exchange rates negatively impacted sales by $42 million and adjusted EPS by $0.05 versus the prior year. Adjusted operating margins were 17.3% in the third quarter expanding 130 basis points sequentially, despite lower sales driven by margin expansion in our Transportation and Industrial segments. We have continued to drive productivity and cost initiatives and have implemented the price increases that we discussed in prior calls. Our pricing is now fully offsetting the impact of higher input costs. Turning to cash flow. In the quarter we once again demonstrated strong cash generation model of our business, with cash from operations of $779 million. Free cash flow for the quarter was approximately $615 million. And through the first three quarters of the year, free cash flow was approximately $150 million which is up 40% year-over-year and roughly a $1.2 billion return to shareholders through share buybacks and dividends. As you may recall, I indicated that we would look to drive our own inventory levels lower, as we saw performance improving in our supply chain. We have been able to deliver improvements to working capital which has contributed to our free cash flow performance this year. As a result of our actions and strong profitability, we expect free cash flow conversion to approach 100% this year. We continue to remain disciplined in our use of capital and our long-term strategy remains consistent which is to return approximately two-thirds of our free cash flow to shareholders and use about third, for acquisitions overtime. Before I turn it over to questions, I want to reinforce that the strategic positioning of our portfolio is enabling us to deliver strong results from secular growth trends. In our Transportation segment, we expect to deliver high single-digit organic revenue growth this year. In our Industrial segment, we expect double-digit organic revenue growth in three of the four businesses for the year. In our Communications segment, we continue to generate strong design win momentum in AI and cloud applications. We are delivering strong operational performance including the work we have done on our cost structure and price actions to offset inflation, enabling our first half to second half margin improvement and EPS expansion as we expected. Overall, this sets us up for a strong finish to the fiscal year and a good step-off point as we enter fiscal '24, which as you know, begins in October. We remain excited about the opportunities we have ahead of us to drive long-term growth, margin expansion and value creation for all stakeholders. So now let's open it up for questions.

Avi, can you please give the instructions for the Q&A session?

[Operator Instructions] We will take our first question from Chris Snyder with UBS. Your line is open.

Thank you. So our Q3 top line only met the guide, but despite a higher level of auto production, so can you even just talk about some of the offsetting headwinds there? And then also what some more color on what really drove the strong step up in margins. Obviously, a step up was inspected, but this was much more significant. And then just lastly, any clicks and takes into Q4 at the segment or end market level. Thank you.

Sure. Thanks, Chris and thanks for the question. First off, when the first part of your question, you know, we met our overall guide on the top line, and you're right in transportation, we were a little stronger, but you know, communications was a little bit weaker. You know, we've been talking for many quarters now about, hey, as we go through some of the supply chain correction and market weakness around cloud, we thought we'd be in the 450 to 500 range and we thought this past quarter we'd be closer to that 450 and you know, our communication segment came in a little bit below that and our transportation revenue, which was stronger, really made up for that. So on your first party of your question on really the margin front, you know, let's just to move it up a little bit, you know, we knew we had to do margin opportunity as we marched through the year. We had the price cost element that as we talked about in automotive, that was going to be on a lag basis. We did get those in place. I think you're seeing the benefit of that and we said we could get our transportation segment back up to where it's at today as we get later in the year and that that's been accomplished. I also think there's been good operating performance in our industrial segment, even in light of, you know, our biggest and, you know, higher profitability business unit there, industrial equipment, you know, has some destocking occurring. So I think that was very good performance there. And the other element is as communications is cycling down here in both businesses, we've been able to maintain the mid-teens margin even on lighter revenue. So I do think, you know, to my prepared comments, I am pleased with the execution that we know we teed up for you all earlier in the year, you know, came through. Now when we go to next quarter, really with the order trends that we're seeing, it does look like, you know, the segments will be very similar next quarter to where they were this quarter. You know, auto production is going to be flat, you know, we expect transportation revenue looks similar to quarter three, similar to IS and CS right now with where we see the order patterns, we expect margin to be similar. So the guide is very consistent with what we just did and that's some of the stabilization that I talked about. And you know, on the EPS side, we're just a little bit lower in quarter four and that's really due to tax and FX. So, you know, it's nice to be able to show some of the stabilization, as we wrap up quarter three and go into quarter four.

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

Our next question comes from the line of Wamsi Mohan with Bank of America. Your line is open.

Yes, thank you. It's really nice to see the operating margin improvement here in transportation that you guys alluded to earlier. But I was wondering if you could Terrence maybe double click on some of your inventory comments. How much more inventory digestion do you think is ahead of us, especially in industrial equipment and how much more correction do you think is also left in in data devices? Thank you.

Yeah. Thanks, Wamsi. And thanks for the question. I guess the first thing is, you know, I know we talked about the stocking and the same benefit we're driving in cash flow as supply chain gets better. It is important. We're not in a bubble where not only our supply chains are getting better, but our broader customer supply chains are getting better. And I think really where you see it in our results are the three business units we have, two in CS and one in IS where we feel it the most. And that's really where we have distribution channel involved and certainly, things aren't as much of a direct, direct relationship. So in transportation, we don't feel there's any supply chain to work off. We don't see impacts of destocking and you see that in our performance and you see the growth in all three businesses. In the other businesses, while TE does do about 20% of its revenue through distribution, the business, as you mentioned appliance and D&D in sees as well as industrial. They do about 40% to 50% of their revenue through distribution. And what we've been seeing is we do see a broader supply chains improve, we see our distribution channel partners adjusting their inventory levels to get to more normal demand. And let's face it. If lead times, people are hitting lead times and people don't need to go to distribution to find something to complete a build, they won't have to do that. So it is a natural effect in our business when you have this, but I think we have to realize it is a good sign that supply chains are improving. I think where we are, certainly, industrial has gotten to it a little bit later. I think we still have a quarter or two that we need to work through in these businesses is our best guess, and guess what, that is a guess. But I do think there'll be a point in time where our revenue in those businesses, especially go through distribution, will get closer to demand. But right now, we're building less on what demand is as inventory works down.

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

Yes. Our next question comes from the line of Steven Fox with Fox Advisors. Your line is open.

Hi. Good morning. I was wondering if you could dig in a little bit more into the cash flow numbers. Like you said, you're up a lot. How sustainable you see cash flow going forward? And maybe what does it mean in terms of your capital allocation? It seems like it's not changing right now, but how does it influence you in a rising rate environment? And then within that, if you could touch on just the M&A environment, that would be helpful also.

Sure, Steve, this is Heath. I'll take this question. First of all, we're pleased with our cash flow performance this year. Year-to-date, our free cash flow is $1.5 billion, which, as I mentioned earlier, is up 40% year-over-year, and we've had pretty consistent results as we -- each quarter as we work through the year. A little -- a big chunk of that to answer your question about sustainability of the space performance builds on what Terence just talked about and that's stability. And if you think about -- there are times, particularly over the past couple of years, when we've had to flex our working capital, particularly inventory to handle all of the volatility that's out there in the various supply chains, both uncertainty from our suppliers as well as differing order patterns from our customers. And the last thing we're going to do is be in a position to hold our customers up. So we've had to flex inventory. So now with the visibility improving, that's tied to some of the supply chain improvement out there, we've had the ability this year and particularly through the first half of this year to reduce inventory levels, bring our days on hand to back more in line. There's a little bit of work to do in a couple of our businesses. But for the most part, we're getting to a better place. And that working capital management has really driven our ability to drive free cash flow improvement year-over-year. So we feel good about that. We feel good in general about our ability to sustain that going forward. In terms of overall capital allocation, which was the second part of your question, was that we're fully funding capital expenditures. We have not cut that back demonstrably -- most of our CapEx goes towards new products and new applications, and that is still real, and that is still happening, whether that's on the EV side or some of the AI opportunities or things within our Industrial segment. So, that's been fully funded. That is unchanged. And then when we start thinking about outside of investing in ourselves, the opportunities out there around the M&A environment Listen, it's always going to be a bit dynamic in terms of what's coming to market and what's available. And we always take the approach that are we the right owner for something that fits strategically well for us and then do the financials work. And I feel like I say that's just about every quarter. But at any given time, we're looking at about half a dozen things. And most don't get across the finish line for one reason or another, but we're active in that process. And there's been some things that that you'll continue to hear us talk about. Over time, I still believe that M&A will take up about a-third of our free cash flow. But it's lumpy. It's not a straight line in terms of the linearity of how that's deployed. So, short answer, no change in our capital allocation strategy. We feel good about where we are from a balance sheet perspective and it allows us to play offense going forward.

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

Yes. Our next question comes from the line of Matt Sheerin with Stifel. Your line is open.

Yes. Thank you, and good morning. Terence, I wanted to drill down a little bit more on the opportunities in AI in your comments. It sounds like you've got a strong relationships with key customers and the semiconductor suppliers. But could you talk about the competitive landscape and the edge you have over competitors? And could you also size up the market opportunities for us perhaps as a percentage of your overall cloud revenue?

Sure, Matt. Thanks for the question. Thanks for the question. And let's face it, we like data anywhere because typically you need a connection to occur. So when you think about the core of what we do, whether it's data, power, or some sort of signal, that's where we see opportunities. And anywhere data goes is an opportunity for us. When you think about AI, though, there's one thing to move data, but when you think about the high speeds that this is at, as well as the low latency you need, it's really an extension of what we've been talking about from a cloud perspective. There's one thing to have a data connector. There's another thing to have a high speed that can handle what these GPUs are throwing off, as well as make sure that you not only have to compute, you also have to move the data. You also have to store the data. And how does that all stay in sync? And that's really, there is a number of us in the world that do that very well because you're at the cutting edge of technology and you not only need to design with the people that build the architecture, you need to be very close to the semi-companies that are making these next generation chips that everybody's all excited about. So when you look at it, I sort of view it's the next step of where cloud went. And we're just taking it up a level of speed. And certainly with the adoption of AI that we all hear about, it's exciting for us. So from a product set, when you look at what we do, we have sockets that actually the GPUs and the CPUs go into. You do need something that takes that semiconductor and connects it into the board. Our high-speed backplane products that actually make sure how the signal moves around. And then you get into things like DAC cables and so forth that actually make sure you're connecting different parts of the rack and boxes together. And we've had opportunities in all of those, similar to we talked in cloud. And what I really like is our position that our team has built, that is both with the semi-customers as well as the ones that are working on the architecture, which are also the cloud guys, really has positioned us well. And like I said, we have over a billion dollars of wins. They probably will go out over a four to five-year period as they ramp. And the momentum is still building on the wind side. So once we work through some of the market correction we're working through in a place like D&D, I think you're going to continue to see the ramp of these programs probably be more in the middle of our fiscal 2024. That will be more visible to you. Some of it's in our revenue already, but the launches will be more in 2024 based upon the launch schedules of our customers that do the architecture build out. And we're really excited about the wins we have and also the problems we're trying to solve with our customers, which is really, in essence, what our engineers do.

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

Yes. Our next question comes from the line of Mark Delaney with Goldman Sachs. Your line is open.

Yes, good morning. Thank you very much for taking my question. I realize the company only formally guides one quarter at a time, but given that we're now in your fiscal fourth quarter, I'm hoping you can provide some early thoughts on fiscal 2024 and how you're currently thinking about trends by end market for next year.

Thanks, Mark, and I also appreciate you giving a caveat that we only guide for one quarter. So anything I'm going to give here will be qualitative about what we see and, some insight because I think I probably talked about some and Heath talked about some already. So first of all, it starts off, it is nice to see the stability that we're starting to see in orders and communications that pick up. So I do think the comments start with that sort of as a backbone. It is important that some of the destocking we talk about in some of our businesses that will work off. I can't tell you the exact date that will be done. But that will -- while that's a headwind now, that will be something as we get into next year will be a tailwind for those businesses. I also think when you look at transportation specifically, our transportation growth this year is going to be driven by automotive is in the low-double-digits. That's on pretty low production growth and it has the content that we've always talked to you about and then a little bit of price on top of that, really, you should expect on top of what auto production is we'll be in that 4% to 6% next year, because we won't have the additional price increases unless material would go up more. And so in transportation, we still see content being the driver into next year. I think the only thing that we're watching real time is in our commercial transportation business. We see some signs in China and North America, that being a little bit slower. So that's one market we're going to keep an eye on. And then when you get into the Industrial segment, you think about the three units that I talked about on the prepared comments. Commercial aerospace is not going to be slowing down in the recovery, and it's one area that we're still playing catch-up in. Medical interventional procedures we feel good about and you're seeing the strong growth there. And renewable applications, we would continue to expect strong growth momentum there. And once we work through the destock and industrial equipment, we'll get back to some of the growth that we've been showing you. And then in the Communications segment, it really is around the destocking and then the AI programs kicking in. So having the stability, I think you see the secular content drivers. We still expect there would be a slow global economy. But really, when you look at these content levers that we've been talking about, will really be the drivers as we get into next year and hopefully, the inventory destocking winds down.

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

Our next question comes from the line of William Stein with Trust Securities. Your line is open.

Great. Thanks for taking my question. First sort of a supply chain question. You've given us a pretty good bit of information already about where you're seeing destocking and such. But like to draw the comparison to some of the semiconductor suppliers who in this cycle was very effective at taking that extended lead time situation as an opportunity to constrain what they were delivering into the channel so that they didn't run into this problem. And I wonder if there are any lessons learned from that? I know every cycle is a little bit different. But as you think about this going forward, is that a potential opportunity to improve the business to constrain what you ship into those guys so you don't wind up in the situation.

So a couple of things, Will. I just want to give a contrast between semi land and what we do, because I do think there is an important difference. Semiconductors had some lead times that were well out over a year. I would tell you, when you look at what we do, our lead time typically on average could be six weeks to 12 weeks. And while we had supply chain challenges, I think the bigger challenge was not as extending lead times. It was meeting lead times. And when I think about the service levels we're at today, which our direct customers feel other than maybe in the aerospace market, our service levels are back to pre-COVID levels from a shift to request element. So I do think there's a big difference on lead times and certainly the semiconductor fab process is very different than the connector process. But I do think while we are around the same trends and we may have stocking and destocking effects, the lead time disconnect between a semiconductor and a connector is very different and ours is much shorter. We did constrain demand in certain areas where we knew we were ahead. You take our clients business, we did not add capacity for our clients business to be permanently at a $1 billion run rate. We were trying to manage through our various channels. So, I think you're always going to have elements of a little bit of stock and destock where you have more channel activity. Let's face it. We build the orders. When we're getting orders we don't say, well this is a real order and this is a fake order. Every order is real, because there is a customer that's asking for something someplace. So I actually feel pretty good how we manage through it. I'm also pretty proud when you look at our communications segment with where their margin is running on how much their revenue is all I think it also proves we've improved the profitability substantially in that segment when we're at maybe a cyclical low that really gets us back to where we can take the margin back up to what we talked about when we target for the segment more like 20%. So there are lessons we think about. I'm not sure it relates to the semiconductor processes as much as how we manufacture.

All right. Thank you, Will. We have the next question, please.

Our next question comes from the line of Christopher Glynn with Oppenheimer. Your line is open.

Thanks. Good morning guys. I had a question about the TS margins. So you have the price fully realize some wraparound into next year. And you also have called out some operational improvements as well. I'm curious, if you could talk about a view of fundamental incremental margin expectations over the next year or two for the TS segment?

Hey, Chris this is Heath. Listen I think TS has done a lot -- the transportation segment in general, but particularly the automotive piece of this as well as the sensors piece of this has done a lot of heavy lifting on the cost structure. And that's largely moving production in a meaningful way away from higher cost locations into lower cost jurisdictions. And we are starting to see the benefit of that in many cases we're also following -- we're part of a supply chain that's also following that trend. So not necessarily unique to us that following our customers to where we need to be to support them. The impact of that on our cost structure is something that has been gradually layering in catching up on inflation with some of the price increases that we've done over the past a couple of quarters has certainly benefited us. And as I think about as we go into next year, the difficult thing to call on that is what auto production number is going to be. We're not terribly bullish as we go into next year that auto production globally is going to ramp possibly [ph]. I guess, more to come as we all get smarter on that by region. But you know the content story, and we do expect the category of EV and hybrid to grow very nicely again just as it's shown in the past couple of years and our content on that. So I feel good about our ability to outperform the market as we've always done and that will lead to some margin opportunity for us. When I think about incrementals we target in normalized times roughly a 30% incremental and more to come on that as we get through into next year, obviously, as you mentioned we'll have some price wraparound for the first half of next year. So I appreciate the question.

Okay. Thank you, Chris. We have the next question, please.

Our next question comes from the line of Joe Giordano with TD Cowen. Your line is open.

Hi guys, good morning. I appreciate all the color on the AI stuff today, but I did have one kind of follow-up there. How do I think about that business replacement for a business that you would have been doing in the absence of AI, like, if I think about your whole data and device business where -- what does that business look like on a normalized basis now? Like it was a $1.5 billion business higher now it's run rating at $1 billion where is like the right pedaling?

Yeah, I think there's a couple of things. You do have the destocking and certainly I would say the one area where I know I talked about distribution a lot there is still a lot of server and semiconductor inventory on the planet that needs to work through. So I do think you're going to have us being below that level right now as that clears out. I would also say just realize just because AI is happening doesn't mean every server and cloud application is obsolete. It is different architecture, but you're still going to get the benefits of those. So I think we're going to get back to normalization in the supply chain, which is driving it. And then you will see AI add on to some of the cloud element. It is not a full cannibalization by any means. And you shouldn't think about it as cannibalization. And we're in the early innings really on AI. I know, I talked about the wins we've had, but the engagements we have are still very strong and you'll start seeing them next year go.

Thank you, Joe. Clear. Next question, please.

Our next question comes from the line of Amit Daryanani with Evercore. Your line is open.

Hi.

Hi, Amit.

This is Abdullah speaking for Amit. And I just wanted to focus on industrial. I think last call you mentioned industrial to be - 150 margin expansion in the second half and you saw a really nice expansion I think of 130 this quarter despite revenues being down I think in the segment $50 million or so. So I was just curious what could be here and what the varies puts and takes on?

Yes. Again this is Heath on the margin question for IS. Listen, I mean, you've got four very distinct businesses within this and you're always going to have a little bit of noise quarter-to-quarter. I think we talked about last quarter some of the mix with the downturn in the industrial equipment business, which is our highest margin component of that segment certainly impacted us. We were able to make up some ground here in our fiscal third quarter with some cost actions as well as just improved profitability in some of the other businesses. So it's a bit of a mix. As you think forward I think listen at this kind of revenue range and with this current mix of what we're talking about the operating margins for the segment probably start with 15. I don't necessarily know that we would dip back down into the 14s like we were last quarter. But this -- as we think forward I think it's in the 15s. And then I think the important piece here is that we are still committed to high-teens operating margins within this segment. We do have a couple of acquisitions that we need to digest that we've taken on over the past year or so. Those have come in with considerably lower margins, but have a really, really strong opportunity to create value through some of the margin improvement and growth opportunities that we've already identified and are implementing that's still running below segment average. And as we get those acquisitions layered in I think that will also have a meaningful impact. So we feel good about our trajectory there. But there's no doubt that we're running a couple of hundred basis points lower than where we want to be longer term.

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

We will take our next question from the line of Samik Chatterjee with JPMorgan. Your line is open.

Yes. Hi. Thanks for taking my question, I guess I had a question on Industrial Solutions as well but more sort of looking at it from a mix perspective just wondering how you think about what this business mix looks like in four years to five years, or how do you want it to look like in four years, five years because from the outside it does look like you have secular drivers in ADM, Energy and Medical whereas industrial equipment I understand sort of the better margin on it but doesn't appear from the outside to have the same drivers in terms of secular growth. So is there a way we should think about how this mix transitions in this business by subsegment of time or where your focus of investment will be as you look at this business?

Well, I think, when you look at the business I think it's important to say where you've seen our investment first. You have seen us been very focused on building out the industrial equipment business unit because we like the factory automation trends that are there. And even if you went back probably three years, four years that was not always the largest business unit. So we have done M&A there. We like the opportunities that are there. We also like the challenges that are there that what are customers trying to solve? You're typically trying to solve getting data off a factory floor in a very harsh environment and getting it back to the compute that turns that into intelligence. So I think you're going to continue to see areas in that space where we continue not only to invest, but also thinking continually about where we can do M&A in that spot. In the other areas that you sit there energy has become much more of a secular driver than we've had and it's where we've really focused around renewable energy. We actually did a small M&A earlier this year. And I think that's an area that we would also continue to look at on top of the secular drivers we have there to say how do we continue to build out that. In aerospace, I would say we're capitalizing on the recovery it's a space that I would say the content is really set because those platforms are won. I don't see there being big secular changes to the platforms right now. We certainly have EVOTL and things like that, but they're further out then your horizon to really create value. So I think it's really more of an execution story. And in medical I think you see the consistent growth and I think you're going to continue to see as we're benefiting from interventional. So I think what's nice about the segment is all four of them have growth drivers in them today. We couldn't say that five years from that five years ago. And I think what you're going to continue to say they all give us different options as we continue to build out those businesses and we'll have times where we do have a little bit of a mix or one has a little bit higher margin than the other, but that's just going to be a factor as we build it out.

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

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

Good morning. Thanks for taking my question. Just wondering if you could comment on the pace of AI-related awards that you're seeing. Just wondering how quickly the billion plus in awards that you've referenced have come together how quickly that could get $1.5 billion or $2 billion? And then related to that in terms of book-to-bill, could you just give us some additional color on overall communications book-to-bill of 0.96, just how that splits between data and devices and appliances and to what extent AI is impacting the data and devices side? Thank you.

Yes. On the -- let's take the last question first. Data and devices is above one. And certainly appliances to below one. I would tell you on both of those where the orders go through distribution the book-to-bill is well below one and the direct customers are above one. So it sort of shows you some of the dynamics. And even in the appliance market, I would say, inventory at the OEMs and at our direct relationships seem to be in check where they need to be where that lower market is. When you look at the wins and an AI to go back the wins are coming fast and furious. And it's one of the things I have to give our team credit for as we were dealing with a market that was turning how do we really make sure we capitalize on those wins. So when you sit there the pipeline has moved up even since the last time we talked we're well over $1 billion now. I think it's really going to be around how these programs ramp and certainly the architecture size. So it wouldn't surprise me that we continue on these calls to update you. But there's no pause in the AI platform. In some cases similar to the EV platform that we had in auto no matter what's happening in the cycle they're accelerating. And I think we'll be able to give you ongoing updates as they ramp.

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

Our next question comes from the line of Shreyas Patil with Wolfe Research. Your line is open.

Hey, thanks so much. So maybe just coming back to Transportation Solutions. If I think about where we are now you mentioned the price increases are fully offsetting material inflation. So you're generating and you're generating about an 18.5% margin, there is going to be some additional outflow potentially some benefits from restructuring. So how do we think about that bridge to the 20% margin target? Are there other headwinds we should be considering as it does seem that is something that could be achieved potentially at some point next year?

First of all, I don't want to commit to anything for 24 until we get closer to 24. So I think we've got to be careful with that. Obviously, we're pleased with the improvement from our first half to our second half both in the third quarter reported results as well as how we feel about how we're going to finish the year in the mid-18s. Our target margin for TS is still 20% and that is unchanged. Obviously, we're approaching 19% now. I want to be careful that we don't commit to something for next year because as I mentioned on an earlier question we got to see where revenue comes out as well. And the thing that we have to keep a very close eye on within this segment is commercial transportation, which is an important piece of the segment. We didn't talk about it too much today, but Terrence had mentioned on an earlier question that we do -- that is our highest margin component of the segment, and we do expect some pressure there next year particularly in China. And so as we think about it it's not just an auto story, it's also the combination of commercial transportation which is a $1 billion business as well as is our sensors business. So more to come on that. But our goal and I feel comfortable over the next couple of years for sure getting to sustainable margins closer to target.

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

Our next question comes from the line of Guy Hardwick with Credit Suisse. Your line is open.

Hi, good morning. Just wondered, if you could differentiate in industrial equipment between sales into distribution sales to original equipment manufacturers. How sharply different are the trends or maybe they're not at all? And I had a follow-up question as well.

Hey Guy, it's Terrence. If you look at it to our direct customers, our book-to-bill is running a rent closer to one. Through distribution is probably running more like 0.8. The only color I would add to you, the industrial equipment business in Asia, which includes the Japanese equipment makers for factory automation who support a lot of things in China and certainly in China. That continues to be weak, both in direct, as well as indirect. But the backlogs of our OEM customers are strong. I would tell you in some cases, we see them working off some inventory, as they were making sure their supply chain they were protected, but there are different trends between our direct relationship and what we're seeing from -- in the distribution channel. And in that business, it's close to 50-50 between the channel and what we do direct.

Thank you. Could you give us an update on your Chinese auto business particularly in electric vehicles? I mean, potentially this market could be 40% NEVs by the end of the year. If there's enough then how TE's position particularly versus local competitors and whether you're fully participating in the growth, particularly one or two very strong domestic players who've done very well of late?

Yes. So, a couple of things. Thanks for the question. So, just -- I'm going to talk, in TE about -- we have about $3 billion of business in China overall, of which two-thirds of that is automotive. I mean, so when you really think about China and TE, the biggest play we have is around EV and Guy, you’re right on. If you want to really participate in EV adoption globally, you have to participate in China or they're the biggest driver of it. And 70% of global fully battery electric vehicles that are adopted on the planet are produced this past year are basically in China. And the thing that I would tell you is, our market share with the local Chinese OEMs versus the multinationals is similar. And you have to realize today, well over 50% of production in China is local OEMs. So, the old days of the multinational brands owning the market, that's no longer the case. And when you look about our content story, our content story is being driven, not only with the multinationals with the local Chinese OEMs and we have a very good share position, content per vehicle when you look at it overall in China, it's pretty similar between the two, whether it's a multinational or a local Chinese OEM and honestly the growth we talked about and our CPV growth is really driven by, we're positioned well with both of them. So I know sometimes people say, well, I'm only with the multinationals. Not in that's not true with TE. TE's on essentially every car in the planet I always say. And what's really nice is what our team has done to really make sure they're penetrating both types of OEMs in China and it's been very important to our growth. And our China automotive business as I said in my prepared comments, all regions in automotive grew this quarter. And also for the year, we'll have growth in all regions. So, certainly we see sluggishness in China outside of automotive. We've actually seen auto production starting to ramp back up again and our positioning there is very strong.

Okay. Thank you, Guy. And I'd like to thank everybody for joining us on the call this morning. If you have any additional questions, please reach out to Investor Relations at TE. Thank you, and have a nice morning.