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TE Connectivity (NYSE:TEL)

F4Q12 Earnings Call

November 5, 2012, 8:30 a.m. ET

Executives

Keith Kolstrom – VP IR

Thomas J. Lynch – CEO, Executive Director

Bob Hau - CFO

Analysts

Wamsi Mohan – BofA Merrill Lynch

Matthew Sheerin - Stifel, Nicolaus & Co., Inc

Amitabh Passi - UBS

Shawn M. Harrison - Longbow Research LLC

Amit Daryanani - RBC Capital Markets, LLC

Jim Suva – Citi

Craig Hettenbach - Goldman Sachs Group Inc.

Steven Fox – Cross Research

Mike Wood - Macquarie Research

Kevin LaBuz – Deutsche Bank AG

Anthony C. Kure - KeyBanc Capital Markets Inc.

Michael J. Wherley - Janney Montgomery Scott LLC

Operator

Operator

Ladies and gentlemen, thank you for standing by, and welcome to the quarter four earnings conference call. At this time, 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 our host, Keith Kolstrom, Vice President Investor Relations. Please go ahead.

Keith Kolstrom – VP, IR

Thank you, good morning, and thank you for joining our conference call to discuss TE Connectivity's fourth quarter 2012 results. With me today is our Chief Executive Officer, Tom Lynch and our Chief Financial Officer, Bob Hau.

During the course of 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 addresses 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.

Finally, for participants on the Q&A portion of today's call, I would like to remind everyone to limit themselves to one follow-up question to make sure we are able to cover all questions during the allotted time.

Now let me turn the call over to Tom for some opening comments.

Thomas J. Lynch

Thanks, Keith, and good morning everyone. Please turn to slide three and we'll get started.

We had a pretty solid Q4, delivering sales of 3.4 billion, adjusted earnings per share of $0.76 and free cash flow of 569 million. Our operating performance was in line with our guidance. And are adjusted EPS benefitted by $0.02 due to a lower tax rate.

Our Transportation business had another strong quarter, while our CIS and Networks businesses continued to experience soft markets as expected.

Overall, I consider this to be a quarter of good execution. Our adjusted operating margin at 13.5% during the quarter and ran just under 14% during the second half of the year despite the fact our Networks business continues to be in a very weak part of the cycle.

Our overall business is now running at a full-year adjusted operating margin of 13 to 14% at the $13 to $14 billion revenue range. So I feel good about the improvement in our operating leverage. However, in this uncertain and slow economic environment, it's also clear that we need to reduce our costs further. I'll touch on this in more detail later in the call.

During the quarter, we resumed our share repurchase program and bought back 5.5 million shares spending just under $200 million.

Integration of Deutsch is proceeding very well. And the touch in services business – divestitures are complete. With these changes, we have a very strong and focused connectivity portfolio.

For the full year, sales were 13.3 billion, down 3% organically versus fiscal 2011. Adjusted EPS was $2.86, also down 3% versus the 52-week fiscal 2011. Free cash flow was 1.43 billion, up 7% versus the prior year. And operating cash flow was right around 2 billion.

I'm especially pleased about our free cash flow performance, which has been strong and consistent over our first five years despite what has been, at times, a volatile and uncertain economic environment. This is certainly one of our most important strengths in the company.

Now, if you could please turn to slide four. Total company sales of 3.36 billion were down 3% versus the 13-week prior year quarter and also down 3% on an organic basis. Currency translation, primarily due to the weaker euro, negatively impacted year-on-year growth by about 400 basis points or 155 million. The Deutsch acquisition contributed $153 million in revenue.

On an organic basis, in Asia, our revenue was up slightly. Automotive continued to be strong across the region, offsetting demand softness in our CIS businesses. Within CIS, the industrial equipment market was especially soft. On the positive side, our small but emerging Mobile business was up 40%.

In China, markets were quite mixed. But overall, the slowest since the '08, '09 timeframe. Our auto business continued to be strong, up 20% year-over-year while our CIS businesses were down 10%.

In Europe, which accounts for about one-third of our total revenue, business was down 5% organically from the prior year level. Most of this decline was in automotive and industrial as our networks business was flat with last year. We expect further seasonal declines in Europe in Q1 due to the seasonality of our business and continued softness in auto and industrial. Right now, the automotive industry is projecting about a 10% reduction in European automotive production in this coming quarter.

Our revenue in North America was down 6% year-over-year on an organic basis. Continued strong demand in our automotive business was offset by soft demand in our Telecom and Industrial businesses as well as our SubCom business.

Please turn to slide five and I'll provide some highlights of our segment performance. As a reminder, beginning next quarter, we will be reporting in our new segment structure and I'll touch briefly on this later on.

Transportation had another strong quarter of performance. This business is now running at a 5-billion-plus annual revenue rate. Overall, vehicle production is now at about an 82 annual unit rate with continued growth. And in 2012, there was strong growth in the U.S. and Japan, moderate growths in China offsetting weakness in Europe.

The industry is currently projecting vehicle production to be about flat in the coming year with the 2012 levels with continued growth in North America and China expected to offset declines in EMEA and Japan.

In the first quarter, we expect revenue in this segment to be up slightly versus the prior year with growth in the U.S. and China offsetting weakness in the industrial and commercial vehicle market and weaker auto production in Europe.

Please turn to slide six. Revenue in our CIS businesses was about $1 billion in the quarter. Most of our markets in this segment continued to be soft primarily reflecting slowdowns in industrial equipment and IT infrastructure spending around the globe. Margins in this segment did improve through the year and we stabilized our consumer business. As the quarter progressed, we did see additional softness in orders in our industrial appliance business. And we expect these businesses to be down sequentially in Q1. Most of this softening in Industrial and Appliances in Asia and Europe.

Please turn to slide seven. Demand in our Networks business continues to be rather weak, especially in the U.S. Telecom and in the SubCom business. Telecom, our largest business in the segment, which accounts for about 1.3 billion of annual revenue has been very soft in the U.S. for about 18 months. It was down 15% in the quarter year-over-year and for the year. In Europe, business was about flat and in Asia, we were up slightly. These are the lowest – these business levels are at the lowest revenue in over five years. And we do expect at least another two quarters of soft demand due to this normal seasonal slowdown.

Now despite the current softness in the market, I continue to remain very bullish about the future of our network segment because the wired portion, primarily fiber portion of our customer's infrastructure is critically important to meeting their capacity in coverage needs. And we have never had a better product line to meet these needs.

Now while this business is slow, we are going to take advantage of this and reduce our costs across the business. We're taking an approach similar to what we did in '08 and '09 with our automotive business.

Now I'll turn it over to Bob Hau, our still brand new CFO to cover the financials in more detail.

Bob Hau - CFO

Thanks Tom, and good morning, everyone. Before I cover the fourth quarter financial performance, I want to remind everyone that the segment reporting changes as Tom mentioned earlier are effective with the first quarter. We will report first quarter results in this new structure in January of 2013. And we expect to file an 8-K with recast historical P&L information in December, well in advance of the January earnings call. Now let me discuss earnings, which start on slide eight.

Our GAAP operating income for the quarter was $401 million, which includes 14 million of charges related to the acquisition of Deutsch and restructuring charges of $39 million. The Deutsch acquisition-related charges includes $7 million of non-cash fair value purchase accounting adjustments and cash acquisitions charges of 7 million. We expect approximately $75 million of total cash charges related to the acquisition of Deutsch. About $40 million of the cash portion was incurred in 2012. With the remainder expected in 2013. The Deutsch acquisition is on track, and EBITDA, exiting the year, was in line with our expectations.

Our adjusted operating income was $454 million with an adjusted operating margin of 13.5%. Both gross and operating margins were in line with our outlook for the quarter. We do anticipate revenue levels and margins to be down sequentially in Q1 due to normal seasonal trends and continued softness in Telecom and Industrial markets.

GAAP EPS were $0.93 and adjusted EPS were $0.76 for the fourth quarter. GAAP EPS included $0.07 of restructuring and other charges, $0.03 of acquisition-related charges, and $0.27 of income related to tax items. The tax income was related to a reduction in evaluation allowances associated with tax loss carry forwards in certain non-U.S. jurisdictions where the ability to use NOL's in future periods now seems more certain than prior estimates.

Please turn to slide nine. Starting at the top half of the slide, our adjusted gross margin in the quarter was slightly above guidance at 31.8%. We expect adjusted gross margins to be down around 31% in the first quarter due to lower sales volumes.

A summary of operating expenses is shown at the bottom half of the slide. Total OpEx spending of $617 million was lower than the prior-year quarter due primarily to the additional week in the fourth quarter of fiscal 2011.

SG&A was up about 100 basis points as a percentage of sales due primarily to the lower sales levels. In Q1, we expect RD&E and SG&A to be approximately 5.5% and 13.5% of sales respectively.

Turning to slide ten, let me discuss items in the P&L below the operating line. Net interest expense was $40 million in the fourth quarter. As planned and discussed in our earnings call in July, in early October, we did pay off notes that matured of $714 million. Therefore, in the first quarter, we expect net interest expense to drop to approximately $32 million and stay at that level through the fiscal year.

Adjusted Other Income, which relates to our tax-sharing agreement, was $12 million. In Q1, we expect other income of approximately $9 million.

A GAAP effective tax rate was negative 5% in the quarter due to the reduction in the NOL evaluation allowances that I discussed previously. The adjusted effective tax rate was 23.5%, which was favorable versus our guidance of 26%. As Tom mentioned, this favorable rate has a positive impact to EPS of approximately $0.02 in the fourth quarter. And we expect adjusted tax rate to be 24% to 25% in Q1 and the full year 2013.

Now turn to free cash flow and working capital on slide 11.

Cash from continuing operations was $714 million, up 17% from the prior year. Our free cash flow of Q4 was $560 million, a very strong finish to the year, and free cash flow for the full year was $1.43 billion. We continue to expect free cash flow to approximate an income going forward.

Capital spending during the quarter was $148 million, and in fiscal 2013, we expect capital spending levels of approximately 4% to 5% of sales, consistent with our historic levels.

Working capital levels are in line with our expectations with receivable days outstanding was 63. Inventory days on hand returned to 69 days. Our businesses continue to do a very good job of managing working capital in this uncertain environment.

Please turn to slide 12 and I'll discuss sources and uses of cash outside of free cash flow.

We begin the quarter with $1.3 billion of cash and ended the quarter with 1.6 billion. During the quarter, we returned a total of $283 million to shareholders. We paid dividends of $89 million and repurchased 5.5 million shares for $194 million. This cash flow statement shows a lower dollar amount per share repurchases due to the time difference of actual payment of funds.

Our outstanding debt was $3.7 billion at the end of the quarter. As I mentioned earlier, debt was reduced by approximately $700 million in early October with the payoff of the notes that matured. We expect debt levels of approximately $3 billion in fiscal 2013. We expect to continue to generate strong free cash flow in future periods. And plan to continue share repurchases of $150 to $250 million per quarter in fiscal 2013.

Now, I'll turn it back to Tom.

Thomas J. Lynch

Thank you, Bob. Please turn to slide 13.

Before I get into the orders and our outlook, I just wanted to refresh everybody's memory on the new segment structure, and this slide shows are fiscal 2012 revenues in the new segment groupings.

The regrouping of our business units into these four segments has two primary objectives as we discussed on the last call. First and foremost, it enables us to best leverage our capabilities for the customer and further optimize our efficiency. It's pretty critical for us. And it also has enabled several of our top leaders to move into expanded or different roles, which is very important for the organization's totality and long term. We believe this will also provide improved information regarding the performance of the company for all of our investors. And as Bob indicated, a recap of historical period results will be filed in December.

Please turn to slide 14. As we alluded to earlier, as we enter into fiscal '13, and I don’t think any surprise to anyone, things are pretty uncertain in much of the global economy. And many of our customers, many of which I have talked to in just the last month, especially tier-one customers are taking a very cautious approach to the outlook, which translates into tightening down the amount of inventory and supply chains; a typical reaction.

As our fourth quarter progressed, we saw our order rates slow. And this slowdown was pretty much across the board in Europe and in our industrial business in the U.S. and Asia. Total orders for the quarter were 3.19 billion. And our book-to-bill was 0.94 excluding SubCom.

This trend is very, very similar to the trend we had in the fourth quarter of last year and our book-to-bill was very similar to the Q4 fiscal year '11 and Q4 fiscal year '10 book-to-bill that we had exiting the fourth quarter.

Please turn to slide 15. Based on the order trends I just discussed, we're currently expecting revenue in Q1 to be in the $3.15 billion to $3.25 billion range and adjusted EPS in the $0.62 to $0.66 range. It's a slight increase over last year and a decline sequentially. On a year-over-year basis, the benefits of Deutsch are being offset by continued weak market for broadband network equipment as well as weaker exchange rates, particularly the euro. Sequentially, the decline is a combination of normalcy finality in most of our businesses coupled with the slowness in Europe and Asia we alluded to earlier.

Please turn to slide 16. For the full year, I'm going to lay out three scenarios, arrange if you will, to show how we would expect our company to perform at different sales levels over the next year.

At the low end, which would be a very slow growth year or no growth year, we would expect revenue to be flat year-over-year, and essentially, our quarterly revenue pattern would mirror last year. You can see this in the lower left-hand corner of the chart. In this case where there's really no revenue growth, which is the benefits of Deutsch being offset by weaker exchange rates, we would still expect to generate 5% adjusted EPS growth as a result of the productivity improvements we continue to see and the benefit of share repurchases.

The midrange scenario or midpoint assumes 3% growth with a modest economic pickup beginning in the second half, and revenue, again, following seasonal patterns. In this case, we would expect EPS growth of approximately 10%. And I would call this, based on everything we see today, we hear from our customers and the assumption people are making about the economy, this is our most likely scenario.

And then the high end of the range assumes a stronger recovery in the second half and drives full-year sales growth of 5% and EPS growth of 15%. The key takeaway from all these; one, it's obviously difficult to call a year out in these circumstances right now. But in any scenario, we would expect to see solid earnings growth even in a no-growth scenario because of our productivity and are strong cash flow, we're going to generate approximately EPS. And if we were to see a pop in the second half of the year across the global economy and a recovery in the Telecom spending, then you could really see our operating leverage kick in generating up to $3.30 in EPS. But as of now, I would say based on everything we see, $3.15 feels like the most likely scenario.

In any of these three scenarios, we would expect to return over $1 billion to shareholders in the form of dividends and share repurchase. And in the most recently completed quarter as Bob mentioned, we did over $280 million in the quarter.

And I guess a core assumption we have is that the first half of our fiscal year is going to continue to be pretty slow economically. And then there will be some – we'll see our seasonal pickup in the second half. And we do expect a little bit of an economic pickup by the time our fourth quarter rolls around. And that would be our July, August, September quarter.

So please turn to slide 17 and I'll kind of wrap things up here.

Although 2012 was a tough year from a demand perspective, I feel we continue to strengthen the company. We improved our operating leverage. We strengthened the portfolio with the addition of Deutsche. And the divestitures of Touch and Services. And had another very strong cash flow year. And to reiterate, since 21007 when we came out on our own, we have generated over $7 billion of free cash flow. And we've returned approximately $4.4 billion to shareholders.

We look forward to 2013. Clearly, these are uncertain times. And a couple of our key markets especially Telecom are in a weak part of the cycle. Despite this, I believe we are very well-positioned to manage through any negative economic scenarios and accelerate our profitability as the economy improves. And I think you could get a sense of that in our Q3 and Q4 with just a little bit of revenue running in the$13.5 to $14 billion level. We're generating 13.5% to 14% operating margins.

In addition, our technology and product pipeline is very strong across the company. Over the last five years, we've been increasing R&D spending, absolute spending because there are so many opportunities in our core connectivity business. And over the next couple years beginning in '13, I expect that we'll begin to realize a wealth of new products particularly in high-speed lightweight and fiber optic applications across our entire portfolio.

And are strong suit, our cash flow and operating leverage enable us to deliver double digit earnings growth even at a low sales growth rate.

But it's also clear that in this environment, we can't depend on normal revenue growth to drive margin expansion. And so as a result, we are taking additional actions to further reduce our costs. Our objective is to permanently reduce costs by an additional $75 million. We expect to hit this annual run rate in the second half of fiscal 2015. We expect to incur approximately $200 million of charges during fiscal 2013. Our current year that we just entered was roughly half occurring in the first quarter.

Cash spending in fiscal 2013 related to these actions is expected to be approximately $150 million. [Inaudible] is a very important investment albeit painful. And at times, to continue to get our cost structure down to the levels that we feel are in sync with the levels of the business.

And with these investments we're making your products and cost reductions, we expect to be able to deliver that 15% operating margin at a lower level than previously anticipated. For those of you who have been following us, 15% operating margin is an incredibly important level of performance for us to hit. That's why we're taking these actions. And we would expect to be able to do that in the $15 to $15.5 billion revenue range.

With that, I’ll open it up to questions.

Question-and-Answer Session

Operator

(Operator instructions). Our first question comes from the line of Wamsi Mohan – BofA. Please go ahead.

Wamsi Mohan – BofA Merrill Lynch

Yes thank you. Good morning. Tom can you talk a little more about what you’re seeing in the automotive market and MAF. We’ve heard from some of the companies of an atypical buildup of inventory of “zero kilometer used cars” is how they dubbed it?

Also curious, are you seeing any softness in China in the luxury car market, and I’ll follow up.

Thomas Lynch – CEO, Executive Director

Thanks Wamsi. Well Europe continues to slow down, and I think right now, and some of it is a little bit of extra inventory. I don’t think it’s overwhelming, because I think the automakers have been adjusting as well as the tier one. But right now the expectation in Europe is to be down 10% year-over-year in Q1 in number of cars produced. And that is our biggest market.

With respect to China, China was - by China measures flow even in automotive through 2012 we had a very strong year again. But production was in single digits for the first time. [inaudible] digits for the first time in a while. Now most of the decline was at the mid-tier to low end vehicles, it was not at the high-tier. We’re seeing a little bit of slowdown at the high-tier, but it’s still fairly robust. I was there last week with our automotive team, and they expect production to be up slightly. Total production of Chinese cars to be – China cars to be up slightly in the year, and for us to have another year of double digit revenue growth, so obviously watching it pretty closely.

Wamsi Mohan – BofA Merrill Lynch

Okay, thanks Tom. As a follow-up, I think you mentioned on the prepared remarks that these additional restructuring actions will kick in, in the second half of this fiscal year. Why is it that it takes so long to realize these benefits? Is it the region where these actions are being taken, and what end markets are these actions gears towards? Thanks.

Thomas Lynch – CEO, Executive Director

Thanks Wamsi. A couple things. If it’s factories, it takes a while with noticed periods and all of those things, and the move equipment. You also typically have in that case, we’re incurring some costs that are operating expense costs in the period of the move. So it does take a few quarters, I’d say typically two or three, if you’re involving factories to begin to see the benefit of the savings. We would expect to see a little bit in Q4, but – and of course we’re doing, we’re pushing for as much as fast as we can, but practically speaking we have to be careful of not disrupting the customer flow.

What was the very last part of your question?

Wamsi Mohan – BofA Merrill Lynch

Just the end-markets where you’re taking these actions.

Thomas Lynch – CEO, Executive Director

I would say primarily around our consumer and networks businesses. Those businesses – you know consumer we’re kind of regaining our footing in that business, and besides a lot of new products now coming into market, part of it is to make sure we have the right cost structures. You know, that’s a very competitive business, and we’re making good progress there. And then in the networks business, it’s because the markets been down for such a longtime, taking the opportunity to make sure that in the event that it’s a lower level of business than we had thought, we still have attractive returns.

Wamsi Mohan – BofA Merrill Lynch

Okay, thanks a lot.

Thomas Lynch – CEO, Executive Director

Thank you.

Operator

Our next question is from Matt Sheerin – Stifel, Nicolaus. Please go ahead.

Matthew Sheerin – Stifel, Nicolaus & Co. Inc

Yes, thank you. So, regarding your commentary Tom on weakness in the industrial markets, I know that a lot of that is through distribution in terms of your overall exposure to distribution, not as much as other suppliers but certainly in the industrial side. Are you seeing sell into distribution at a lower rate than sell out like we say last year when we saw an inventory correction? Or are you getting signs that just demand from the distributors is weak and will continue to be weaker?

Thomas Lynch – CEO, Executive Director

I would say it’s more just sell out is weak. I will also say Matt that we do have a pretty substantial amount of our business go through the channel for the company as a whole of 20%. In our industrial businesses it’s closer to 50%. So we leverage the channel, benefit from the channel, work with the channel quite a bit.

Matthew Sheerin – Stifel, Nicolaus & Co. Inc

Okay. And then on the cost cutting actions that you’re taking, it sounds like it makes sense on the networking side. Are you looking at mostly manufacturing related cost, as opposed to technical sales and support, because we are potentially at the bottom of the market here and you don’t want to take those kind of costs our and those kind of resources out right?

Thomas Lynch – CEO, Executive Director

We totally agree with that and as we did in the big downturn three and a half years ago, we didn’t take those kind of resources out. We believe that’s really kind of the heart and soul of the company, and that’s where we create our value. So, no, it’s more around excess capacity that – hey I think there’s a couple of things. We’re getting smarter, we’re getting better with our leans, so we’re creating capacity every year, which if you go back two or three years ago we would have expected to use for growth, but in these times we don’t need it, and so we’re going to take advantage of the slowdown and take some of this capacity offline and move it into other locations.

Matthew Sheerin – Stifel, Nicolaus & Co. Inc

Okay, thank you.

Thomas Lynch – CEO, Executive Director

Thank you.

Operator

We have a question from Amitabh Pass – UBS. Please go ahead.

Amitabh Pass – UBS

Thank you. I had a clarification and then a question. My clarification was, in you EPS guidance for fiscal ’13, have you already embedded the potential impact of your share repurchases of somewhere between 150 to 250 million per quarter?

And then Tom, my question for you was, your (Y line) segments, whether it be your telecom, fiber business, the service provider segment, of Subsea has been weak for quite some time. Just wanted to get your thoughts on what do you think spurs incremental spending there, particularly in North America? And is there a need for you to perhaps bulk up the macro cellular wireless piece of your business to perhaps complement what’s going on with the wire line markets?

Bob Hau –CFO

Hi, this is Bob. From a share repurchase standpoint, as we’ve indicated, we’re planning about 150 to 250 million per quarter in 2013. We did restart the fourth quarter of ’12, and that is baked into the EPS guidance per employer.

Thomas Lynch – CEO, Executive Director

And on your question about the networks business, it really depends on where – the cycle depends on where we are in the world. So Europe is kind of flattish right now. Some carriers there are being very aggressive pushing fiber deep, others are backing off typically because they did it a few years ago. But in general, fiber’s still not that deep in the network. It’s deepest in the U.S., but it’s still not close enough to the home or the office to handle all the digital content that’s coming. And then in Asia, it’s still growing, although it’s lumpy. And then you have big programs like what’s going on in Australia and New Zealand.

In terms of small bay station, we have through the ADC acquisition what is commonly referred to is the (daftedness) or distribute antenna, which is – it’s the forerunner of small bay station I would say. The capability to add on capacity and coverage without having to build a tower, and clearly that’s where the industry is going, especially in the U.S. We have a product line there that we feel pretty good about. But we’re more excited about, as you build out all these small bay stations, to get the signal back on to the main network you need to connect them with fiber. So these small bay stations in supporting an LTE Network are going to be out pretty close to the home, in order to have the bandwidth that you need for the home, and they will be in our view predominantly connected by fiber. So, in the last year and a half, we’ve had the acquisition activity in the carriers in the U.S. and we’ll tend to slowdown spending. And then I think a really big push to get 4G or LTE out there, and at the expense of some of the wired infrastructure.

So, we’ve seen these cycles before. When we’re in the bottom of them, they always feel pretty tough, and there are those moments when it seems like it’s never going to come back, but we really like the product line we have and we feel we’re very poised for when that investment cycle hits again.

And then with respect to SubCom, as you know, that’s a very cyclical business and it’s at the low end of the cycle. Five years ago it was at the top end of the cycle, and life couldn’t have been better. But even at the low end of the cycle it’s a good business returning cost to capital. And when you model bandwidth around the world and nobody is perfect at this, and we expect another growth cycle to come in the next few years.

Amitabh Pass – UBS

Excellent. Thank you.

Thomas Lynch – CEO, Executive Director

Thank you.

Operator

We have Sharron Harrison – Longbow Research. Please go ahead.

Sharron M. Harrison – Longbow Research LLC

Hi, good morning. Two questions, just the first on Deutsch. Maybe if you could just – it sounds as if things are going pretty well there, but if you could maybe talk about just how it’s progressing, what we should expect from that business in ’13 and both kind of just the earning contribution whether you think there’s upside or challenges?

And then just second, the raw material environment, if you’re facing any incremental headwinds right now, or if you think you’re kind of relatively neutral to raw materials? Thanks.

Thomas Lynch – CEO, Executive Director

Thanks Sharron. With respect to Deutsch, going very well. The cultural – and I’ve been to most of the locations is very good as we’ve said before, our people have been in these similar businesses a longtime, so there’s an initial point of understanding to start with, which I think is important. The business is a little slower than, you know when we bought it. The assumptions we had when we bought it, I think that’s reflective of the slowdown in the global economy. The synergy is higher, so on balance we expect the earnings contribution from Deutsch in ’13 to be as we stated at the time of acquisition, which I’m pretty pleased with given it’s a little softer topline. We also feel there’s – the longer term there’s a little more opportunity than we thought from a sales perspective. The ability to take these products, some directly, some with modification and other applications so, so far so good. I have a tremendous amount of enthusiasm I think with the Deutsch team and us about what the prospects are.

And then with respect to raw material.

Bob Hau - CFO

Raw materials for us, about a push for 2013 perhaps a very small tailwind if copper, gold, and silver stay where they’re at today, but it would be low single digit millions of tailwind if it were to hold, particularly given where we stand from a hedging standpoint.

Also add on a Deutsch standpoint, I mentioned in my opening comments, we exited 2012 about on expectations from an EBITDA standpoint. As Tom pointed out, sales a little bit late. Integration cost coming in better, integration segments coming in better than we had anticipated. So, we actually crossed the 30% EBITDA margin in the second half of 2012 in the first six months of ownership. So, we’re very pleased from that standpoint.

Operator

(Operator instructions). Our next question is from Amit Daryanani with RBC Capital Markets, please go ahead.

Amit Daryanani - RBC Capital Markets, LLC

Yes, thanks a lot, good morning, guys. There’s two questions on my side – one, just on the Deutsch side, you touched on this a little, but, you know, your revenues were 27 million off, which you guys were initially expecting last quarter from Deutsch – even though the rest of tel transportation segments seem to have held a blow, what do you think Deutsch under performed on the revenue line so severely?

Thomas J. Lynch – CEO, Executive Director

The biggest part, Amit, is in the heavy truck business – you know, with slow down and industrial activity, so that’s really where we’ve seen it. I think you’ve seen some of the companies, the big OEM’s, how they’re guiding in that area in the last month, and they’re big customers of ours. And China, we’re starting to see acceleration again towards the new café – equivalent to the café standards which is a big opportunity for us, and was one of the core series of the case, for doing Deutsch, where today trucks in China are, unlike the automotive market, a truck market is all kind of local and at the low end with a few exceptions, but with a new, much more strict emissions standards that should come into play over the next year-and-a-half, and get ready for that over the next year, we see a really big opportunity there. But in the short term, it’s off-road heavy truck.

Amit Daryanani - RBC Capital Markets, LLC

Good, that’s helpful, and then, you know, could you just touch on what drove the sequential margin declines for the transportation segment? Was that about 160 basis points – was that largely just a revenue mix, or something else that impacted that? And then how do you think that segment will perform in fiscal ’13 – you know, that you’re baking into your guide?

Thomas J. Lynch – CEO, Executive Director

Amit, from a sequential stand point, you hit it right on the head, it’s definitely associated with the lower revenue partially on a seasonal basis. We saw a bit of weakening in operating margins just from a standpoint of leverage through the factories.

Bob Hau - CFO

At the – and Amit, at the 13.7, $3.15 EPS scenario, I would expect the margin in that business to be up modestly.

Amit Daryanani - RBC Capital Markets, LLC

Fair enough, thanks a lot.

Bob Hau - CFO

It takes another year of good performance.

Operator

Our next question comes from Jim Suva with Citi, please go ahead.

Jim Suva – Citi

Thank you, congratulations to your team. Can they talk a little bit about the restructuring – is it mostly attributed to activity or ADC, or Deutsch, or a combination of the three? Proportionately, how would you think about where their structure actions are?

Thomas J. Lynch

That’s a – I appreciate that question, Jim, and thanks for the complement. It’s hard to cut it that finely because, you know, ADC’s been a part of us almost two years now, but if you were to go back and look at some of the locations we’ve already announced – you know, there’s a couple that are ADC locations that were originally contemplated, you know, as part of this synergy, and we’re doing more than we originally contemplated because the business is slower. There is a little bit of fine tuning in Deutsch, I would say. Again, as we get smarter, and as Bob mentioned, we’re identifying more synergies.

If you want to break it down, the business is – I mean, we’re going through and finding wherever we have excess capacity that’s still may not be where the customer is going, or where the customer has gone – it’s an ongoing journey to make that happen. But generally speaking, you could say the majority of it is going to be around Consumer and Network.

Jim Suva – Citi

Okay, and then as a quick follow up, with this restructuring actions going on, is your M&A pipeline still very active, or has this slow down economy you’re taking a cause on it, or are those people focused on restructuring – are they like different [inaudible]? I’m just trying to get a feel for your M&As? You talked about stock buyback, you talked about restructuring but M&A, just really didn’t come up, and I’m just wondering about your outlook [inaudible]?

Thomas J. Lynch – CEO, Executive Director

No, our M&A headline is still full because I think in that case, it’s all part of understanding what’s going on in your markets, and we certainly have areas where we’ve said many times that are very attractive to us if the right opportunity was available, desire to do something, and it was the right price. So, I think we have a group of people that work with our businesses that are constantly making sure that that pipeline is growing in the sense that we’re identifying all the companies out there, so we’re on top of our mark. So, I would say, clearly the threshold for doing one is higher, and as I said last quarter, we’ve done two sides of the ones in the last two years, and our priority is to make sure we make them successful, and I feel very good about where we are on that journey with those two acquisitions. So, in a sense that it gets harder and harder to – the threshold gets higher and higher, and likely to be smaller size, really true [inaudible] in the area where we are most interested in. So, we don’t want to, in a sense, restrict the pipeline, because I think, you know, we could run, and maybe misunderstand what’s going on in the market, and to miss opportunities, because many of these take a long time to come to fruition.

Jim Suva – Citi

Thanks, and congratulations to your team.

Thomas J. Lynch

Thanks, Jim.

Operator

Our next question is from Craig Hettenbach with Goldman Sachs, please go ahead.

Craig Hettenbach - Goldman Sachs Group Inc.

Yes, thank you. Tom, you called out the parallel to the restructuring actions to automotive market in ’08, ’09. So, I was hoping to get a sense of the operating leverages [inaudible] in that business kind of coming out of the down turn, if you see any similar parallels to the earnings power for the networks and consumer once end demand comes back?

Thomas J. Lynch

Yes, I – in automotive we picked up a point-and-a-half to two points, we also did increase our investment in R&D, and that business at that time, especially in hydroelectric and a few other areas. We – I would expect in the businesses we’re primarily focused on to get a similar kind of leverage a point to two points in consumer or networks, that’s the objective, and the opportunity is there because the team has identified, you know, the excess capacity and how we could take advantage of locations that have capacity.

Craig Hettenbach - Goldman Sachs Group Inc

Okay.

Bob Hau - CFO

Overall, we expect about $75 million worth of savings, which once we get up to that run rate in the second half of 2015 – Tom indicated, we see an accelerated opportunity to get to the 15% operating margin, $75 million will remain to [inaudible] point at the total [inaudible] connectivity level.

Craig Hettenbach - Goldman Sachs Group Inc

Got it, thanks for that – and then as it relates to the [inaudible] location, the buyback is [inaudible] this quarter. Any thoughts on the dividend, which if you look at your payout, even though you steadily increased it sense it’s been out, it’s still, you know, below the overall market, and just really curious how you think about that payout ratio, if there’s on opportunity over time to increase that from where it is today?

Thomas J. Lynch – CEO, Executive Director

Well, we do think for us, depending on where we are in the cycle and what our other opportunities are, that payout ratio in the 25-35% range isn’t – would be a right ratio for us. And as you know, we’ve been consistently increasing the dividend, I would expect that at the upcoming board meetings in advance of our annual meeting, that’s certainly a topic that we will be reviewing with the board to see what we want to do in the coming calendar year regarding payout, but we have to take into consideration what does the economy look like, what do the other opportunities look like, but our philosophy would be consistent increase in the dividend rate, we just have a lot down with that [inaudible] yet for the coming year. Okay?

Operator

We have a question from Steven Fox, Cross Research. Please go ahead.

Steven Fox – Cross Research

Thanks. Good morning. Two questions, first, as it goes to the restructuring, I was just curious what it implies about your typical incremental margins, whether there’s been any change there or the ability to realize meaningful sales synergies from Deutsch over a longer period of time?

And then secondly, Tom, maybe you could just talk a little bit more about China, around the other markets there seems to be – seems to be the lynchpin maybe for the next six months in terms of which way the economy goes globally and how your operations have improved over the last year or two there. I know you’ve been – had some initiatives underway to bring them up to par maybe with other areas, so that will be helpful. Thank you.

Thomas J. Lynch – CEO, Executive Director

Just a point of clarification on your first question, restructuring relative to Deutsch?

Steven Fox – Cross Research

No, the overall restructuring, the new restructuring charge that you’re announcing. I’m trying to understand what it implies about your typical incremental margins, if you have to take cost actions here.

Thomas J. Lynch – CEO, Executive Director

We’re addressing fixed costs, primarily in the restructuring. So the goal is to continue to improve the flow through on higher volume growth. So yeah, we – we typically fluctuate between 25 and 30% depending on the mix of businesses and the region it happens in and you know, we want to continue to reduce where it makes sense and we don’t sacrifice capacity for growth, that’s fixed cost base. So that’s the way to think about that.

As far as Deutsch sales synergy, I think it’s early, but we’re seeing it for sure in the two key markets. You know, we’re seeing opportunities of one having the complete product line going into a customer and from soup to nuts providing the heavy-duty connectivity system and that’s beneficial to customers, they’re telling us they like that. It simplifies their life. I think overtime, that is an opportunity. The shorter-term opportunity is to take advantage of our channel strength around the world where we have a large – a large infrastructure or I’d say an effective infrastructure that works with our channel partners to support all the smaller customers, generally smaller customers around the world and we’re seeing increased activity around this product line from Deutsch from through those partners, in many cases, not sold by the channel partners before. So that would be early synergy. And then in the longer-term, I think it’s really the opportunity to get more design-ins because can provide more of a system and we can solve the problems in a more effective way having this complete range of products for the harsh environment.

And then with respect to China, yeah, we have quite a presence in China. As you know, about $2 billion of revenue. We have substantial engineering resources there, obviously manufacturing resources there. Our strong suit in China is in our Beacon business, automotive where we’ve been supporting the automotive industry there, both multi-national and the locals for a long time. I think we’re doing, you know, we’re doing well in the Telecom business. Telecom and Energy are tough businesses in China, lots of low competition, but we’re in the upper echelon of suppliers, not huge businesses – and the balance of this business in China, typically, not to generalize too much, but a [inaudible] export business where – whether it’s computers or mobile phones or even industrial equipment. You know, we have a – more than a beach head there.

So – but clearly, China getting energy and getting a pickup in their environment, then I was encouraged from my visit and talking to our folks last week that it – it looks like that transitioning government over there comes soon, the desire to get the economy going, stimulus flowing again in some areas and the recognition that that economy needs to grow 7.5 to 9% to keep the country moving forward. But for the last year it’s been slower than I’ve seen other than the, you know, the crisis here.

Steven Fox – Cross Research

Thank you very much. That’s helpful.

Thomas J. Lynch – CEO, Executive Director

Thanks, Steve.

Operator

You have question from the line of Mike Wood with Macquarie. Please go ahead.

Mike Wood - Macquarie Research

Hi, good morning. Regarding the outperformance that you’re expecting with global auto production, is that being driven by higher content per vehicle or Deutsch synergies or is this just better performance on the high end? And can you talk about whether or not you’re worried about a trade down impact as the economy is slowing?

Thomas J. Lynch – CEO, President

Sure. It’s not really Deutsch related in the automotive business. They bring a little bit of capability, but they’re more harsh environment. It’s continuing content at every category of cars, A, B, C, D, E. It is selective expansion beyond our traditional product line in areas like sensors. It’s continuing to lead, we’ve invested a lot for a long time in light-weight and be able to connect alternative metals and copper and we’ve got tremendous capability there. So it’s a combination of factors that contribute to us growing a little bit faster than the market.

Mike Wood - Macquarie Research

Okay, and the growth that you mentioned in tablets and smartphones, are these new wins with customers or are these just an expansion with your current business?

Thomas J. Lynch – CEO, President

We’ve had a couple of significant new wins, not enough to say, you know, we’re well established yet. I think enough to tell our customers that, hey, we really are a good capable, innovative supplier to these markets and to tell ourselves that we can do it. So the last year was an important year for us to convince more than anything ourselves that this is a market that we should be able to be successful in. So it’s a couple of more wins, not just extensions of existing wins. And, of course, in that business, you’ve got to have wins all the time because unlike automotive or industrial, you don’t typically get designed in with a particular part number that lasts that long. It is – if you’re not that well established in the business, it’s a good thing because it gives you a chance to get established, but it does make pretty ferocious business. So you have to be good at it and you have to be quick to ramping volume, which has not been our strong suit in the past, but which we’re getting much better at.

Mike Wood - Macquarie Research

Great. Thank you.

Thomas J. Lynch – CEO, Executive Director

Thank you.

Operator

Sherri Scribner with Deutsche Bank. Please go ahead.

Kevin LaBuz – Deutsche Bank AG

Hi. Thank you. This is Kevin LaBuz on for the behalf of Sherri. It’s really no surprise given the macro situation that you’ve seen it slowdown in sales, but I’m wondering what have you seen on the design side? Has the pace activity there slowed?

Thomas J. Lynch – CEO, Executive Director

Not really. You know, we’ve seen a little bit and I’d say there are really one-offs where when things slow down, sometimes customers slow down their efforts to introduce something that might be cutting edge. But we haven’t seen even a lot of that, a couple things where we were close to getting designed in and then the customer decided, in light of the market, to hold onto the incumbent solution.

But for the most part, the customers aren’t slowing down their demands on the number of designs. I think that’s not in their best interest and you can really lose a lot of momentum if you have a customer doing that. You want to have a pipeline of design so that when things do come back and they spend more money, they’re ready. And a lot of what we do in this industry, supporting our customers, whether it’s high-speed or light-weight or fiber optic related are important parts of the architecture. So it’s not just a simple component that gets dropped into a design, it is very often a component that is custom designed or partially custom designed for their application. And in many of our industries, the consumer might have the shortest cycle but in almost any industry, next-generation products are designed several years out and if you delay that, you really run the risk of missing a window.

So we’ve kept our investment, that’s why I said earlier, even with the restructuring, we’re not touching engineering. You look at our investment in engineering over the last five years, it’s gone up. I just think we have so much opportunity that we felt like we were going to go after it. But I guess to answer your question, we have not seen much change in the design demands of our customers.

Kevin LaBuz – Deutsche Bank AG

All right, thank you. And just on – just turning to Asia, there’s been a lot of talk about slowdown in China, but what do you think in other geographies there, including China, what about Asia?

Thomas J. Lynch – CEO, Executive Director

I would say, and it really depends on market, but to generalize a little bit, Japan had a strong year in ‘12 and I would expect them to have a very slow year in ’13. You know, the post-earthquake bounce really drove some business there, but we’re seeing that slow down already.

China, by typical recent measures, I would say had a slow year although a growth year. Expect that to pick up a little bit, we’re seeing signs of that in our order rates this quarter. Korea, steady, I would say. You know, low growth, but steady growth and of course, continuing to have significant exports in the auto and in the mobile device business. So those being the three big markets. Southeast Asia, very promising, growing market. Places like Indonesia really – standards of living starting to improve and investments starting to grow there. And Australia/ New Zealand, pretty significant investments in infrastructure and relative to us, Telecom infrastructure so very important there, those governments have made a statement that having a full broadband solution across the country is important to being competitive. By the way, I think we’ll see that over time everywhere and that’s one of the reasons we’re so bullish on our Networks business.

Kevin LaBuz – Deutsche Bank AG

Excellent. Thank you.

Thomas J. Lynch – CEO, Executive Director

Thank you.

Operator

We have a question from Tony Kure, KeyBanc. Please go ahead.

Anthony C. Kure - KeyBanc Capital Markets Inc.

Hey, good morning. Just a quick question on the guidance for fiscal ’13. As you look at the EPS and the revenue lines, I’m sort of trying to back into the EBIT margin improvement. We’ve already talked to your expectations on the transport side, but you know, overall for the company, I’m looking at sort of a 20 to 30 basis point operating margin improvement. First, is that correct? And second, how would it be influenced by the other segments, the two segments at this point?

Thomas J. Lynch – CEO, Executive Director

That’s directionally correct, yeah. You’re in the ballpark with that. With that kind of revenue growth we would expect the productivity we have in the pipeline to generate that kind of operating margin.

Anthony C. Kure - KeyBanc Capital Markets Inc.

And then like you talked about the transport being up marginally, could you talk about the other two segments from the margin expectations?

Thomas J. Lynch – CEO, Executive Director

Yeah. I would say…

Bob Hau – CFO

I think ultimately to your point, the 20 to 30 basis points operating margin is about right on a year-over-year basis. Transportation being the strongest one given some growth opportunities there. The other three segments; industrial, consumer and networks, all expanding on a year-over-year basis, but to a smaller level given the lack of volume leverage from those three individual segments.

Anthony C. Kure - KeyBanc Capital Markets Inc.

Great. And then on the Enterprise IT side, obviously slowing down there, just – if you have visibility into what’s driving that, I mean, we’ve heard a lot about the C-level decision making extending, a lot of projects pushing out. Do you have that sort of visibility that these types of things are pushing into 2013 or are these just cancelations on run rate business? Maybe if you provide [inaudible] down onto that market?

Thomas J. Lynch – CEO, Executive Director

I think, again, it depends on the region of the world and the customer. There’s some customers that are very aggressive and pushing us for earlier implementation of next-generation, high-speed solutions. There are some that are, in light of the economic circumstances and holding capital budgets in an uncertain economy are living with the solutions they have. So I would say it’s mixed, but if I were to categorize in one area, I’d say it’s more of a push than a cancelation. We often don’t – we don’t see too much kind of cancelation because I think from an end – our customer’s point of view, that’s not a smart thing for them to do. It’s easier for them just to push rather than lose the attention of the supply base and the continued innovation and investment we bring.

Anthony C. Kure - KeyBanc Capital Markets Inc.

Okay, great. Thank you so much.

Thomas J. Lynch – CEO, Executive Director

Thank you.

Operator

And our last question is from Michael Wherley, Janney. Please go ahead.

Michael J. Wherley - Janney Montgomery Scott LLC

I just had a question about the consumer restructuring and you know, if you’re seeing some program wins there, where does exactly is consumer restructuring? Does it have to do with customers that lost share or is it just more broad based?

Thomas J. Lynch – CEO, Executive Director

It’s really about tightening up the capacity, Michael, and when I talked about the organization change we made three months ago, that had been in the works for a while, it was really founded on grouping like businesses together and making the final break from what had always in this company been structured as a regional geographic business and making the transition to a vertical global business. So in the past, consumer really was three businesses in the Americas, Europe and Asia. We concluded a couple years ago that that was not going to enable us to be, one, cost effective, or nimble in responding to the needs of that market. So part of the capacity in the restructuring that you hear us talking about is really tightening up the backend of that business now that we’ve had it as standalone for about nine months now and you know, getting scale because time to volume and scale in that business is critical to getting the margin you need to make it an attractive business and I’m encouraged with the leadership and team we put in a year ago, the progress they’ve made in that year both on new products, important new wins that the key customers and the customers are setting the pace in that market. As well as making a lot more sense out of the backend of that business and making us much more efficient.

Michael J. Wherley - Janney Montgomery Scott LLC

Okay. And what’s your core confidence that you can – that you’ve gotten better at sort of the quick ramp ups where you’ve struggled in the past in that consumer business?

Thomas J. Lynch – CEO, Executive Director

Growing confidence. We have a couple of really great success stories with a couple of the biggest and the most demanding customers and they were – they were critically important for us, of course because we don’t have a long track record of doing that, so we – very important products for these customers that we did a very, very good job, and you know, in one case, helped them out of a bind. So I think we’re building our confidence and their confidence in us, in this business. You’re only as good as your last experience, so you, you know, we have to be good every time. So far, so good, knock on wood. But you know, we’re not – we’re far from declaring victory and probably never would anyway, but I think our team’s confidence in the ability to make this a good business is growing.

Michael J. Wherley - Janney Montgomery Scott LLC

Okay. Thanks very much. The last question I have is just sort of on your LEAN opportunities across TE. You know, separate from the restructuring, what sort of headwind are you making with LEAN and how does that sort of tie in with the current restructuring?

Thomas J. Lynch – CEO, Executive Director

The headwind on LEAN is really good and I think you could start to see it in the year last year where we had the actual flight shrinkage in some of our markets, in revenue and overall, and you know, the operating margin held in there nicely. Three years ago, that would not have been the case. So LEAN is focused on taking the waste out of the process and it’s a – it’s been around, it’s a tool-based program, it requires a lot of discipline and strong site-by-site leadership and it’s – it is implemented at every site we have; some further along than others. But in at least half our sites, and we refer to it as a Star 3, you get when it’s actually improving your performance. So it’s a – it’s a journey that takes a lot of perseverance. It is helping us, and it is bringing up physical capacity, which plays into some of the decisions we're making now.

Michael J. Wherley - Janney Montgomery Scott LLC

Thanks very much.

Thomas J. Lynch – CEO, Executive Director

Thank you all very much for the questions.

Keith Kolstrom – VP, IR

Thanks very much for joining the call today. Please call the IR team with any follow-up questions.

Operator

Ladies and gentlemen, that does conclude our conference for today. Thank you for your participation and for using AT&T Executive Teleconference Service. You may now disconnect.

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