Amphenol - Q1 2023

Transcript

Operator (participant)

Hello, and welcome to the Q1 Earnings Conference Call for Amphenol Corporation. Following today's presentation, there will be a formal question-and-answer session. Until then, all lines will remain in a listen-only mode. At the request of the company, today's conference is being recorded. If anyone has any objections, you may disconnect at this time. I would now like to introduce today's conference host, Mr. Craig Lampo. Sir, you may begin.

Craig Lampo (Executive VP and CFO)

Thank you very much. Good afternoon, everyone. This is Craig Lampo, Amphenol's CFO. I'm here together with Adam Norwitt, our CEO. We would like to welcome you to our Q1 of 2023 conference call. Our Q1 2023 results were released this morning. I will provide some financial commentary. Then Adam will give an overview of the business and current trends. Then we will take questions. As a reminder, during the call, we may refer to certain non-GAAP financial measures and make certain forward-looking statements. Please refer to the relevant disclosures in our press release for further information. The company closed the Q1 with sales of $2.974 billion. GAAP and adjusted diluted EPS of $0.71 and $0.69, respectively.

Q1 sales were up 1% in US dollars and organically, and up 3% in local currencies compared to the Q1 of 2022. Sequentially, sales were down by 8% in US dollars, 9% in local currencies, and 10% organically. Adam will comment further on trends by market in a few minutes. Orders in the quarter were $2,896 million, which was down 16% compared to the Q1 of 2022 and flat sequentially, resulting in a book-to-bill ratio of 0.97 to one. The lower book-to-bill was driven by lower bookings in the communications-related markets, which continued to experience a decline in demand. GAAP and adjusted operating income were $592 million and $597 million, respectively, in the Q1 of 2023.

GAAP and adjusted operating margins were 19.9% and 20.1% respectively in the Q1. On a GAAP basis, operating margin decreased by 10 basis points compared to the Q1 of 2022, and decreased by 70 basis points sequentially. GAAP operating margins for the Q1 included $5 billion of acquisition-related costs. On an adjusted basis, operating margin increased 10 basis points compared to the Q1 of 2022, and decreased by 80 basis points sequentially. The year-over-year increase in adjusted operating margin was driven by strong operating leverage on the modestly higher sales volumes. On a sequential basis, the decrease in adjusted operating margin reflected normal downside conversion on the lower sales levels.

Our team continues to execute strongly in the quarter, and we are proud to have sustained these strong levels of profitability despite the continued range of challenges around the world, including the moderating conditions in several of our communications-related markets. In particular, we truly appreciate the quick reactivity of our teams working in the communications markets, who took appropriate actions to preserve strong profitability in the face of downturns in customer demand. Breaking down Q1 results by segment. In the Harsh Environment Solutions segment, sales were $854 million in the Q1, which was an increase of 17% in USD and 15% organically versus prior year. Segment operating margin was 26.5%.

In the Communication Solutions segment, sales were $1.127 billion in the quarter, which was a decrease of 15% in US dollars and 13% organically versus the prior year. Segment operating margin was 20.5%. In the Interconnect and Sensor Systems segment, sales were $993 million in the Q1, which was an increase of 10% in US dollars and organically versus the prior year. Segment operating margin was 18%. The company's GAAP effective tax rate for the Q1 was 20.9%, and the adjusted effective tax rate was 24.0%, which compared to 23.8% and 24.5% in the Q1 of 2022, respectively.

GAAP diluted EPS increased 4% to $0.71 compared to $0.68 in the prior year period. adjusted diluted EPS increased 3% to $0.69 compared to $0.67 in the Q1 of 2022. Operating cash flow in the Q1 was $532 million, or 125% of adjusted net income. Net of capital spending, our free cash flow was $436 million, or 102% of adjusted net income. We are pleased to continue to deliver a strong cash flow yield. From a working capital standpoint, inventory days sales outstanding, and payable days were 93, 72, and 52 days, respectively.

The higher inventory days were primarily driven by the lower sales level in the Q1, together with some continued impacts from the supply chain disruptions that our industry experienced over the past year. Our management team is focused on bringing the inventory days back down into a more normal range over the coming quarters. During the quarter, the company repurchased 2.1 million shares of common stock at an average price of approximately $79. When combined with our normal quarterly dividend, total capital return to shareholders in the Q1 of 2023 was more than $290 million. Total debt on 31 March was $4.6 billion, and net debt was $3.1 billion.

Total liquidity at the end of the quarter was $4.5 billion, which included cash and short-term investments on hand of $1.5 billion, plus availability under our existing credit facilities. Q1 EBITDA was $708 million. At the end of the Q1 of 2023, our net leverage ratio was 1.0 times. We are very pleased that the company's financial condition remains extremely strong by any measure. I will now turn the call over to Adam, who will provide some commentary on current market trends.

Adam Norwitt (President, CEO, and Director)

Well, Craig, thank you very much, and allow me to extend my welcome to all of you on the phone here today, and I hope you all are enjoying a lovely spring so far. As Craig mentioned, I'm gonna highlight some of our achievements here in the Q1. I'll then discuss our trends and progress across our served markets, and then make some comments on our outlook for the Q2. Of course, we'll have time for some questions at the end. With respect to the Q1, our results were stronger than expected, exceeding the high end of guidance in sales and adjusted diluted earnings per share. Our sales grew from prior year by 1% in US dollars and 3% in local currency, reaching $2.974 billion.

On an organic basis, our sales increased by 1% with growth in commercial air, broadband, military, automotive, and industrial markets, largely offset by declines in the IT Datacom, mobile networks, and mobile devices markets. The company booked just under $2.9 billion in orders in the quarter, representing a book-to-bill of 0.97 to one. Our operating margins, adjusted operating margins in the quarter reached 20.1%. That was a 10 basis point increase from last year's levels. As Craig just mentioned, we achieved this still very robust level of profitability despite the ongoing cost challenges around the world, as well as declining volumes in many of our communications markets. This is just an excellent reflection of the strength of our company's execution in these very dynamic times.

Adjusted diluted EPS grew 3% from prior year to $0.69. We generated strong operating cash flow of $532 million and $436 million respectively in the quarter. All clear demonstrations of the high quality of Amphenol's earnings. I'm just extremely proud of our global team of Amphenolians around the world. The company's results this quarter once again reflect the discipline and agility of our uniquely entrepreneurial organization as we continue to perform well in a very dynamic and challenging environment. Turning to our progress across our various served markets, I would just comment that we remain very pleased that our end market exposure is still highly diversified, balanced, and broad.

This diversification continues to create great value for Amphenol, it because it enables us to participate across all areas of the worldwide electronics industry while not being disproportionately exposed to the risk associated with any given market or application. With that said, the military market represent 11% of our sales in the quarter. Sales in this market grew from prior year by a strong 15% in US dollars and 16% organically. This was really driven by broad-based growth across most segments within the defense market. Sequentially, our sales increased by 2%, which was in line with our expectations coming into the Q1. As we look into the Q2, we expect sales to increase modestly from these Q1 levels.

We remain very encouraged by the strength of the company's position in the defense market, where we continue to offer the industry's broadest range of high technology interconnect products. As the geopolitical environment has become certainly more dynamic, nations around the world are expanding their investments in next generation defense technologies, thereby increasing the long-term demand potential. We look forward to supporting this increased demand with our wide array of interconnect and sensor products together with our expanded capacity resulting from the investments that we've made in recent years.

The commercial aerospace market represented 4% of our sales in the quarter, and sales increased by a strong 42% from prior year and 44% organically as we benefited from the continued recovery in global aircraft production.

While aircraft production may not yet be back to the levels that it was before the pandemic, we are very pleased that after several very challenging years in this market, our team has driven our sales essentially back to pre-crisis levels, a really great achievement. Sequentially, our sales grew by a much better than expected 15% from the Q4. As we look into the Q2, we expect sales to remain at these Q1 levels. I'm just so grateful to our team who works in the commercial air market. You know, with the ongoing recovery in travel and thus demand for jetliners, our efforts to strengthen our breadth of high technology interconnect products while diversifying our market position into next generation aircraft are paying real dividends.

We look forward to realizing the benefits of these initiatives here in 2023 and beyond. The industrial market represented 28% of our quarter, of our sales in the quarter, and our sales in this market grew from prior year by 11% in US dollars, 14% in local currency, and 5% organically. This growth was driven in particular by sales into traditional and alternative energy generation, heavy equipment, rail mass transit, factory automation, and medical applications, together with contributions from our acquisition program. On a sequential basis, sales were up 2% from the Q4, which was a bit better than our expectations.

As we look into the Q2, we expect sales in the industrial market to remain at similar levels as we saw here in the Q1. our outstanding global team working across the industrial market continues to find new opportunities for growth across the many distinct segments of this exciting and truly diverse market. I remain confident that our long-term strategy to expand our high technology interconnect, antenna, and sensor offering, both organically and through complementary acquisitions, has positioned us to capitalize on the many revolutions that are happening around the industrial electronics market. We look forward to realizing the benefits of this strategy for many years to come.

The automotive market represented 22% of our sales in the quarter, and sales in the Q1 grew 9% in US dollars and 14% organically, with our growth supported once again by strength of our sales into electrified vehicle applications, together with other products sold into a wide array of new electronic systems in cars. While sales in Asia were slightly down from prior year, we realized strong growth in North America and Europe in the automotive market. Sequentially, our sales declined by 5% from the Q4, which was a bit better than our expectations coming into the quarter, and that just reflected strong execution by our team in reacting to opportunities with customer demand. For the Q2, we expect a modest sequential increase in sales from these levels.

I just have to say that I remain truly impressed by our team working in the automotive market. They continue to grow our global position by remaining focused on driving new design wins with customers who are implementing a wide array of new technologies into their vehicles. In particular, our long-term efforts in expanding our now comprehensive range of next-generation interconnect products that are incorporated into electrified vehicles has enabled us to expand our position with a wide range of customers, all of whom are pursuing carbon-neutral driving solutions, and that creates further potential for the business. The mobile devices market represented 9% of our sales in the quarter. Sales declined by 15% from prior year as growth in smartphones was more than offset by declining sales into laptops, tablets, and wearables.

Sequentially, our sales declined by a slightly better than expected 31% from the Q4. As we look into the Q2, we do expect a further mid-teen sales decline from these Q1 levels. There's no question that the mobile devices market remains one of our most volatile. Nevertheless, our outstanding and agile team has adjusted their resources in real time with the changing levels of demand and stands poised as always to capture any opportunities for incremental sales that may arise in 2023 and beyond. Our leading array of antennas, interconnect products, and precision mechanisms continues to enable a broad range of next-generation mobile devices, which positions us well for the long term. The mobile networks market represented 4% of our sales in the quarter.

Sales declined from prior year by 19% in US dollars and 17% organically as operators and equipment manufacturers reduced their demand after several quarters of stronger consumption. Sequentially, our sales in the Q1 were down by 11% from the Q4, which was a bit more than we had expected coming into the quarter. Now as we look into the Q2, we do expect a further low double-digit sequential decline in sales as operators further moderate their spending. Our team continues to work aggressively to realize the benefits of our efforts to expand our position in next-generation 5G equipment, as well as the networks being constructed around the world.

While there is currently seemingly a pause in the investment cycle, when customers once again drive renewed construction of these advanced systems, we look forward to benefiting from the increased potential that comes from our unique position with both equipment manufacturers and mobile service providers. The IT Datacom market represented 17% of sales in the quarter. Sales did decline by 21% in $ and organically as both service providers and equipment manufacturers moderated their demand in light of still significant levels of inventory across the market. On a sequential basis, sales declined 17% from the Q4, which was a touch better than our expectation of 20% down coming into the quarter. As we look towards the Q2, we expect sales to remain roughly at these Q1 levels.

Regardless of this current correction in demand, largely due to inventory, we remain encouraged by the company's outstanding position in the global IT Datacom market. Our team's just done an outstanding job developing leading high speed, power, and fiber optic interconnect products that are enabling our OEM and web service provider customers to continue to drive their equipment and networks to higher levels of performance. With exciting new applications, including in particular alternative intelligence or AI, together with the continued growth in overall data traffic, we're confident that we'll be able to realize the benefits of our leading position in this important market for many years to come. Finally, the broadband communications market represented 5% of our sales in the quarter.

Sales grew by a very strong 17% from prior year and 18% organically as we experienced a significant increase in demand from cable operators for a wide range of our products. This growth was driven by increased network build-outs as well as our customers preparing for new government-supported spending on expanded broadband coverage, particularly here in North America. On a sequential basis, sales declined by 15%, slightly worse than our expectations coming into the quarter. As we look into the Q2, we anticipate a mid-single-digit sequential moderation of sales from these Q1 levels as broadband operators temper their procurement levels.

Nevertheless, we remain encouraged by the company's strong and expanded position in the broadband market, and we look forward to continuing to support our service provider customers around the world, all of whom are working to increase their network coverage and bandwidth to support the proliferation of high-speed data applications to homes and businesses. Turning to our outlook, the current economic environment remains for sure dynamic and highly uncertain. In addition, we do expect reduced demand to continue in the Q2 across the communications-related markets. Assuming market conditions do not meaningfully worsen and also assuming constant exchange rates, for the Q2, we expect sales in the range of $2.89 billion-$2.95 billion, and adjusted diluted earnings per share in the range of $0.66-$0.68.

This would represent a year-over-year sales decline of 6%-8% and adjusted diluted EPS decline of 9%-12%, again, compared to the Q2 of prior year. Nevertheless, I remain confident in the ability of our outstanding management team to adapt to the many opportunities and challenges in the current environment and to continue to grow our market position while driving sustainable and strong profitability over the long term. Finally, I would be remiss if I didn't take this opportunity to offer my true gratitude to our entire global team around the world for their outstanding efforts here in the Q1. Operator, with that, we'd be very happy to take any questions.

Operator (participant)

Thank you. The question and answer period will now begin. Please limit to one question per caller. Our first question comes from Amit Daryanani with Evercore. You may go ahead.

Amit Daryanani (Senior Managing Director)

Thanks a lot. Good afternoon, everyone. Adam, I was hoping you could expand a bit more on the communication segment softness that you're seeing. I think we've talked about the IT Datacom softness for a few quarters now. It sounds like maybe it's incrementally there on the mobile network side as well. Would love to get your perspective, if you think this is more demand-driven or inventory-driven issue. From your vantage point, you know, what do you think is the duration of the softness correction as you go forward? Thank you.

Adam Norwitt (President, CEO, and Director)

Well, thanks very much, Amit. I mean, our team working in the communications market has been wrestling with quite some vacillations in demand. If you just look back over the prior couple of years, we had just fabulous growth in all the communications markets, in particular in IT Datacom, but we also had strong growth in mobile networks and decent growth in the mobile devices. I think what we've seen as we came into the end of last year and certainly coming into this quarter, that in particular in the IT Datacom market, there was a significant degree of overbuying of components, not because we had disappointed our customers. Quite the contrary.

We were constantly coming to the rescue of our customers over the course of their boom in demand with the agility that they've come to expect from Amphenol. Regardless, they seem to have opened their aperture of procurement across virtually everything that they buy in light of the supply chain crisis, and that included building up inventory of our products, certainly which we saw with hindsight. Relative to the mobile networks market, I'd say this is not as much an inventory issue as it is the dynamics of service provider spending. I think it's kind of well reported, the ups and downs of the various service providers and their capital plans.

I think what we've seen in particular in mobile networks is we've seen the early stages of operators building out their 5G networks, and we benefited, no doubt about it, from that build-out with the long-term efforts that we put in to build our position across those next generation systems. Sometimes what you see is initial build-outs, and then they digest it, and they figure out the economics, and then they come once again to build out a next phase. I would tell you that in most of the places where we operate, places like North America, Europe, and otherwise, these 5G networks are certainly not fully built out, quite the contrary. They've built out the rough framework of them.

It allows them to get a certain amount of coverage, start to realize a certain amount of economic return for their investments. Then as typically happens, they would at a certain point start to do further investments to build up more capacity in those networks. When that happens, we'll be well equipped to deal with that. I mean, the other communications market, mobile devices, this is one that is very volatile. We saw in particular last quarter still really robust strength in smartphones, but that was offset or more than offset by fairly dramatic declines in the overall demand for computing devices like laptops and tablets. I think that's also a well-reported dynamic with the kind of pull forward of demand of those kind of devices as everybody went to work from home.

If our office is any indication, you know, work from home is a distant memory because as Craig and I come into the office, the parking lot is full, the cubicles and the offices are quite full here. I think that mad rush to equip people for working from home with those various devices has a little bit changed the cycle of replacement of them and maybe bunched a bit more into the prior two years. Last I'll talk about is broadband, which is, you know, our kind of fourth of the communications markets. We had just outstanding performance in broadband last year, and that continued here into the Q1. And that was really supporting our customers with a really broad array of products.

We've dramatically expanded the range of products that we sell into the broadband market, and that resulted in us taking significant position with our customers. I mean, we grew, as you'll recall very well last year, by 38% organically and 62% in USD with the variety of acquisitions that we've made in recent times, and still robust double-digit organic growth here in the Q1. I think now we see a little bit of digestion of those customers, as we look into the Q2. No doubt about it, the position that we built over the last couple of years in broadband is something that we think long term is going to create great value for the company.

Operator (participant)

Our next question comes from Wamsi Mohan with Bank of America. You may go ahead.

Wamsi Mohan (Senior Equity Research Analyst)

Yes, thank you. Adam, curious as to why you think this weakness is contained within communications. I mean, you are so diversified even within communications, radio consumer exposure and mobile. You have enterprise and cloud exposure and IT Datacom carrier exposure and mobile networks. Given that, like, why is this... You know, it sounds like it's a very broad macro kind of slowdown. Is this just more early cycle given some of the inventory things that you noted? You know, we should expect some moderation even in industrial and auto and other areas as we go through the course of the year. Is that the right way to think about it? If I could, would love to get your perspective on trends in China as well.

I'm not sure if you had a chance to get over there, but you typically do. Now that it's opened up, if you have or even if you've not, it would be great to get some perspective on what you're seeing on the ground in China. Thank you.

Adam Norwitt (President, CEO, and Director)

Yeah. Thanks very much, Wamsi. look, I don't think that the communications markets and the dynamics that I just discussed, which are quite unique in each of them. We're talking about one dynamic in IT Datacom, a different in mobile networks, a different again in devices and yet again in broadband. I don't think that that is an indicative or leading indicator for a broad economic situation. You know, quite the contrary, we've given guidance for next quarter for all of our markets, and I don't think that guidance reflects a kind of a broad economic slowdown, quite the contrary. Relative to China, I mean, I'm glad you asked the question.

You know, it was just early last month when China changed its visa policies. As soon as the news came out that visas were reenacted, literally that day, we booked our flights, and Craig and I were in China at the very first day of April. What a pleasure it was. I can't tell you. To be three years away from our team in China, who just did such a phenomenal job over these three very challenging years. In particular, over last year, which was particularly challenging in certain places, including in Shanghai. I tell you, I had the opportunity to meet some of our factory workers who went into a bubble in Shanghai for more than six weeks in one case.

Just to be able to see them and to be honest, to like, hug them and thank them for all what they did on behalf of the company during that time period was just a tremendous satisfaction for me. Not to mention Craig and I, somehow we didn't gain weight with all the food that we ate over that week of visiting 21 of our operations in China. The trends in China, I tell you, being there on the ground, this does not seem like a place that is going into deep recessions. Infrastructure investments continue apace. You see new rails for high-speed trains next to virtually every highway you go on.

What I was most impressed by was our own operations and what they have done during this time period when nobody was visiting them. And it's a credit to how we're organized as a company, that we don't have just subsidiary factories that are relying on a whole infrastructure outside of China to function, but rather we have standalone entrepreneurial organizations like we do around the world, run by general managers and their teams, and what amazing work they did over this time. Driving growth in technology, developing new products for the China market, not relying on Western countries or engineers who may be subject to government restrictions that can be applied from anywhere that you think of, but rather developing native capabilities inside of Amphenol.

Also, many of our Chinese operations had during that time for a variety of reasons, the incentive to set up operations outside of China and doing that while still not being able to travel, going to a place like Vietnam or to India or to Thailand or even Mexico and setting up satellite factories on behalf of their customers who wanted to have China plus one or something like that. It was just really exceptional to see that. And another reminder of what really makes this company special. You know, are there trends in China, are there macro issues, long-term things like population growth or lack thereof? Sure. Are there geopolitics that are sitting kind of at the highest levels between Beijing and Washington? Sure, they are.

I can tell you when you go on the ground, you meet with the people, there you get really encouraged, as I do everywhere that I go around Amphenol, from the U.S. to Mexico to India to Western Europe, and now finally being able to go back to China, and I look forward to going back again soon.

Operator (participant)

Our next question is from Samik Chatterjee with J.P. Morgan. You may go ahead.

Samik Chatterjee (Managing Director, Equity Research Analyst)

Yeah. Hi. Thanks for taking my question. Adam, just wanted to see if I can get some of your thoughts about how you're thinking sort of for the second half of the year, with the guidance that you have for 2Q. The first half you're going to be down a bit year-over-year, but the orders have now stabilized. Is that giving you a bit more visibility into the opportunities for growth or for the opportunity for the aggregate sort of company to grow in the second half or maybe even for the full year? Any thoughts there? Thank you.

Adam Norwitt (President, CEO, and Director)

Yeah. Thank you very much, Samik. Look, I mean, we're not giving full year guidance because it does remain a very volatile environment. As much as I would love to sort of get out ahead of my skis and tell you that, you know, the second half is gonna give growth or not give growth, I'm gonna refrain from doing that here today. I can tell you this, that the company remains strong. The base of our strength with customers, the financial condition of the company, I mean, just look at the margins that we were able to secure in the Q1 despite real volatility that we saw in our communications markets. Craig mentioned that very specifically. I mean, it's just another testament to the underlying strength of the company.

To the extent that in the second half customers want more product from us, for sure we're going to support them with that. I think today, sitting here just on the 26 April, it's premature, given how dynamic it is, for me to give a sense of what, you know, Q3 and Q4 and ultimately the full year is going to bring. You can bet our team has high aspirations, but we're also realistic to the environment that's in front of us, and we're gonna manage through whatever comes our way.

Operator (participant)

Our next question is from Steven Fox with Fox Advisors. You may go ahead.

Steven Fox (Founder and CEO)

Hi. Good afternoon. Adam, I was just looking back at your earnings track record for the long period of time. If I take out the COVID period, the early COVID period, you're experiencing a down year of earnings for the first time since 2009. I was just curious what you think about this cycle relative to prior cycles where, you know, your earnings are down and what steps you're gonna take to maybe sort of mute that earnings decline in coming quarters. Thank you.

Adam Norwitt (President, CEO, and Director)

Yeah. Well, thanks so much, Steven Fox. I mean, look, we'll see how the year goes. As I just said to Samik Chatterjee, I have no idea, and certainly I'm not gonna talk about what the full year earnings will be. But what I did say just now, I think really resonates when you bring up 2009. Because whether it was 2009 or even 2001, and you're probably one of the few people on the call who's been closely associated and following us since that time, and I certainly have been in the company for that time or longer. The way that Amphenolians manage through dynamics is to just face it up. We don't kind of punt it.

We don't say, "Well, the good times are going to come," or, "Let's wait another quarter. Let's wait a Q3," then we have to play catch up and get behind kind of the curve of the cost. Rather, we see what orders we have, we see what our customers want, and if we have too few or too many resources, we make adjustments rapidly. That gets reflected then in the profitability of the company. As you know very well, what distinguished our company, whether it was in 2009, 2001, or in that sort of COVID environment of early in 2020, was from peak to trough, our margins declined just 300 basis points during very, very significant downturns in demand.

Now, we're certainly not, with our guidance in the Q2, guiding to such kind of cataclysms as we all saw in 2009, but at the same time, it's a dynamic world. So our playbook hasn't changed whatsoever. Even if the size of the company is significantly bigger than it was in 2009 and, you know, categorically bigger than it was in 2001, our sort of modus operandi is the same. That culture of entrepreneurship, which is today represented across 130 General Managers, and maybe in 2009 it was, like, 50, and in 2001 it was, like, 20, it's still the same way to deal with it. These GMs are out with customers every day. They're listening to them.

They're immediately coming back, reacting in real time to adjust resources accordingly. If you have less orders, less demand, you take out costs, then you go out and you take market share. That's the approach of Amphenol. It has been my entire 25 years in this company, and it will be for as long as I can secure that. You know, who knows what it's going to be this year. We certainly don't aspire to have a reduction in our EPS, if demand is softer than it was last year, we'll manage through it.

Craig Lampo (Executive VP and CFO)

Yeah. Steve, this is Craig. I think I just would add just one thing to that. I think that if you look even in the Q1 results, and we've said this a couple times, but if you look at the Q1 results and you take into account that we have, you know, three or four markets that are reducing sequentially by, you know, double digits...

Adam Norwitt (President, CEO, and Director)

You really just see that, you know, resiliency from a margin perspective and the ability for the company to kind of react to those kind of, you know, reductions. I mean, the mobile devices market is certainly normally used to having kind of reductions like that, but places like IT Datacom, you know, mobile networks, you know, broadband, these are not markets that typically have that type of volatility from a quarter-over-quarter basis. I think that you really as that's kind of, you know, shows through just in the results for the Q1. As Adam said, I don't think that would, you know, be any different, you know, in the future.

The bottom line is, you know, we're driving for continued growth and we'll react to, you know, demand reductions where that may be.

Operator (participant)

Our next question is from Luke Junk with Baird. You may go ahead.

Luke Junk (Senior Research Analyst)

Yeah. Thank you for taking the question. Adam, hoping you could just comment on the focus areas specifically for the IT Datacom Group right now as the market goes through this consolidation period. Is the fact that you're able to catch your breath after what you already referenced today as a very busy multi-year period, in some respects, actually a positive relative to the longer term positioning of the business? I guess if I look at the margin side, 27% decremental margins for Communication Solutions could have been worse. On the demand side, you know, looks like there's some interesting AI-related opportunities that are emerging on the horizon, if you could speak to both those things. Thank you.

Adam Norwitt (President, CEO, and Director)

Luke, well, thank you very much. I'm glad you emphasized this. I mean, this 27% downside conversion margin for an organization that is already making pretty robust margins is really phenomenal. By any measure, it's a reflection of that quick reactivity that I was discussing earlier. Look, I would be lying if I told you our folks working in that market are happy to have a little bit of a downturn to kind of, to use your phrase, catch their breath. Nobody likes dealing with this, but we do it. It is what it is. Like it's we don't sort of punt reality. It just is what it is.

At the same time though, what's interesting is while we're making sure that the financial strength of the company stays as robust as it did, and again, the 27% conversion margin that you mentioned is a great indicator of that, we are working on an extraordinary array of next generation technologies. You know, just 'cause customers have some extra inventory doesn't mean they don't have an enormous amount of next generation things that they're trying to achieve. You, you mentioned, and I think I alluded to, you know, AI as one of those.

I mean, these are the kind of revolutions that drive kind of quantum leaps in the demands of our customers for processor power, for speed as it relates to data transmission and networking, all of which creates demands on the equipment for next generation high speed interconnect, for the fiber optics and for the high efficiency power interconnect that's so important to sustaining the operating expenses and let alone the carbon footprint of these massive processors that are going into these enormous data centers. So we haven't slowed down at all as it relates to developing and designing next generation products together with our customers. You could actually argue that in certain cases we've had to accelerate those efforts as customers have gotten into competitive situations with others on things like AI, machine learning and the like.

That's the kind of carrying water on both shoulders that is an Amphenolian trait as well. It's not something necessarily I emphasize so much, but we talk a lot in the company about, you know, driving with one foot on the gas, one on the brake, you know, carrying water on both shoulders. Sometimes you gotta go out and cut costs at the very same time as you're ramping up engineering support for next generation systems. Being able to do that, having the mindset and the agility to do that is I think a very unique trait that is resident inside our organization. That includes within all of those working across IT Datacom.

Operator (participant)

Our next question is from Chris Snyder with UBS. You may go ahead.

Christopher Snyder (Executive Director)

Thank you. I wanted to ask on IT Datacom. I know obviously that's been a segment that's been, you know, I guess the most impacted so far by inventory digestion. You know, I think in Q1 you guys said it was down about 17% sequentially, and if I heard it right, it sounds like the sub-segment expects to be flat sequentially in Q2. And I know there's seasonality involved, but does that indicate that, you know, that sub-segment is moving past maybe the bulk of some of the inventory digestion headwinds that have impacted the segment over the last three, four quarters now? Thank you.

Adam Norwitt (President, CEO, and Director)

Thanks. Thanks, Chris. Look, I've talked a lot about IT Datacom, but to the specific of your question, I mean, I don't know what the second half is going to bring. I certainly hope that Q2, and the fact that we see sales to be flat is an indication that we've kind of reached a little bit more of an equilibrium. 90 days from now, I hope to be able to give you a better sense of that as it relates to the second half, but it's certainly a better indication than if we had seen, you know, another leg down on a sequential basis. We'll see what the second half brings.

Again, the fact that it's flat in the Q2 gives me some hope, but 90 days from now, we'll try to give you a little more certainty about that.

Operator (participant)

Our next question is from William Stein with Truist Securities. You may go ahead.

William Stein (Managing Director and Senior Analyst)

Great. Thank you for taking my question. I'd like to just linger on these relatively weaker end markets for a moment, just to get a slightly more clarity. In the weakness in comms in general, are you seeing that more pronounced in any particular geography? Within IT Datacom specifically, is that more hyperscalers where you're seeing the weakness, or is it more broad-based across all sizes and shapes of customers? Thanks.

Adam Norwitt (President, CEO, and Director)

Thanks very much, Will. I wouldn't point out any significant geographical distinction across the communications markets. I mean, remember that a lot of these communications products, a lot of them still get made in Asia, especially on the device side and a good portion of the, at least the OEM products of the IT Datacom. You can imagine that in Asia, you know, that's having a worse situation overall for the company. Sure enough, you know, in Asia, we did not have as robust performance in the quarter as we did in North America and Europe overall, and that's driven a lot by that. Otherwise, I wouldn't say that there's any sort of end customer geographic changes here.

Relative to hyperscale versus the equipment manufacturers, again, I don't think there's a real distinction because ultimately the hyperscale people are also customers for the equipment manufacturers in many cases. I think that that overall inventory position is fairly broad across both areas of that market.

Operator (participant)

Our next question comes from Mark Delaney with Goldman Sachs. You may go ahead.

Mark Delaney (Managing Director and Senior Equity Analyst)

Yeah. Good afternoon. Thanks for taking the question. I'm gonna touch a little bit more on supply chain and what it might mean for your own free cash flow generation. You know, given demand softer, do you think supply chain stabilizing enough that perhaps you can take some inventory down and lead to better free cash flow here? Thanks.

Adam Norwitt (President, CEO, and Director)

Yeah, thanks. Thanks, Mark. Yeah, I mean, at Q1 we actually had, you know, good cash flow. I mean, 100% essentially of our, you know, yield on, you know, for the Q1, which for a Q1 actually is probably better than average. But given that, I do recognize that our inventory was even a little bit higher than we would typically want it to see it, you know, here in the Q1 from a days perspective. You know, there's many reasons for that. I mean, we had a, you know, certainly a very strong 2022. We had supply chain issues, you know, throughout the majority of the year of 2022.

I think that as we came into the Q1, where days typically get higher normally, you know, there certainly is kind of a lag effect or a hangover effect from a, you know, from a supply chain, you know, perspective as well. I do believe that, you know, the team certainly will have some impact on that over the coming quarters, and we should see some improvement from a days perspective, you know, on inventory, which just naturally will help from a cash flow. I think, you know, our target cash flow continues to be 100% or 90% to, you know, 100% kind of from a, from a free cash flow perspective. I think that certainly that should be, you know, achievable here and for, you know, for the full year.

There may be a quarter or two, we're actually a little higher than that as we kind of bring inventory a bit down.

Operator (participant)

Our last question today comes from Guy Hardwick with Credit Suisse. You may go ahead.

Guy Hardwick (Analyst)

Hi, good afternoon.

Adam Norwitt (President, CEO, and Director)

Hi, Guy.

Guy Hardwick (Analyst)

Could you expand a little bit on the industrial segment, which is now, you know, by far and away your largest segment, I think you said 28% of sales. I know factory automation is probably the largest end market within that. Can you give us a little bit more color of trends within industrial, whether it's medical or energy?

Adam Norwitt (President, CEO, and Director)

Well, thanks. Thanks very much, Guy. I mean, the fact is, Industrial is, at least this quarter our largest segment. It was 28% of our sales. At the same time, Industrial is far and away our most diversified market. I mean, there's really not a correlation amongst the various segments within Industrial, except that they all represent harsh environments where our customers are trying to push new electronics deeper and deeper into some of the harshest of environments, you know, to an offshore windmill, into a semiconductor factory, into an operating theater, onto a train going 400 kilometers an hour and everything in between. In terms of the segments, you know, I wouldn't say that necessarily factory automation is the largest.

It's a significant segment, but we have strong sales into areas like heavy equipment and medical, instrumentation, which includes things like semiconductor manufacturing into electric vehicles, heavy electric vehicles and battery, all types of energy generation. That includes both alternative energy, but also traditional energy, extraction and generation, rail mass transit, things like marine and entertainment. I mean, you can tell these are not markets that correlate with one another. If we're gonna have one of our markets be, you know, a little bit bigger than the others, in this case, still just 28% of sales, this would be the one that you'd want to have that. We're just really excited by the progress that we've made in our industrial market over a very long time period.

If I go back to 20 years ago, I mean, this was a relatively small business that we didn't really have a close touch with where it went. It all went through distribution. We had just fabulous leadership in our industrial business over that time, who really drove a very much an application and segment-based approach to developing new products. Application-specific, technology-specific products. At the same time as we made a number of great acquisitions over many years, We continue to make great acquisitions across the industrial market that have ultimately positioned us for these just multitude of revolutions going on as electronics gets pushed deeper and deeper into harsher and harsher environments.

It's not just one or another piece of that, and we're just really excited about the ongoing strength of our industrial market, which has just been a fabulous asset for the company for many years and I believe will remain so for many years to come.

Operator (participant)

We do have one additional question from Michael Anastasiou with TD Cowen. You may go ahead.

Michael Anastasiou (Executive Director and Senior Research Analyst)

Good afternoon, guys. Thanks for taking my question. You know, looking at the capital deployment side, you had a couple deals announced at the beginning of the year. Can you just describe how CMR and RFS fit into the overall strategy? On a broader front, what end markets or adjacencies do you see the most opportunity inorganically for the year? Thank you.

Adam Norwitt (President, CEO, and Director)

Thank you very much, Michael. Well, CMR, as we announced, we closed earlier in the year, and that's a fabulous company making harsh environment value-add interconnect products that go into the industrial market, in particular in heavy equipment. RFS, we announced that we signed the acquisition, we have not yet closed it. We, as we said last quarter, we expect to close by the end of the Q2, we don't change what we say about that. RFS really expands our position in the mobile networks market, with really high technology antennas and fiber optic solutions that go into next generation mobile networks. We're, again, very excited about that company, our team continues to work closely with the RFS team as we get closer to bring them into the Amphenol family.

In terms of our pipeline of acquisitions and where we see the future, we don't pick and choose our markets and say, "Well, that's the market where we want to make acquisitions," or, "That's the market where we don't want to make acquisitions." The reason for that is when we make an acquisition, we're getting married forever. We're not a trader where we buy companies and sell them and buy and sell and kind of do this portfolio management. We look for companies with great people, with outstanding enabling technologies, and robust and complementary market positions across all of our end markets.

In our experience, which stretches over, in my career, more than 75 acquisitions, and I think more than 50 since I've been CEO in these 15 years nearly, that having that very simple approach leads to really outstanding long-term, long-term success and a great return on our capital that we deploy towards the M&A program. Our acquisition pipeline remains very robust today. I remain wholly incapable of predicting when we will close and if we will close certain deals, but I know that long term the program's going to continue to support really great growth for the company and a great use of the capital and the cash that we generate, so much of.

We look very much forward to continuing our M&A program, and it really complements the culture of the company as well, 'cause every time we bring in one of these new entrepreneurs, it actually strengthens the entrepreneurial culture of Amphenol, and that's something that I look very much forward to as well.

Craig Lampo (Executive VP and CFO)

Michael, just to clarify, just to avoid any confusion, RFS, since we have not closed on it yet, is not included in our guidance and wouldn't be included in guidance until we close.

Adam Norwitt (President, CEO, and Director)

Well, very good. I think we have no further questions, operator. If that's the case, I would like to take this opportunity to wish all of you a wonderful continuation of your spring. We look forward to talking to you all just 90 days from now. Thank you so much, and best wishes to you all.

Craig Lampo (Executive VP and CFO)

Thanks, everybody.

Operator (participant)

Thank you for attending today's conference, and have a great day.