TE Connectivity - Q1 2014

Transcript

Operator (participant)

As a reminder, this conference is being recorded. I would now like to turn the conference over to our host, Keith Kullman, Vice President of Investor Relations. Please go ahead.

Keith Kullman (VP of Investor Relations)

Thank you. Good morning, and thank you for joining our conference call to discuss TE Connectivity's Q1 fiscal 2014 results. With me today are Chairman and Chief Executive Officer Tom Lynch and 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 address the use of these items. The press release and related tables, along with the slide presentation, can be found on the Investor Relations portion of our website at te.com.

Finally, I would ask for participants on the Q&A portion of today's call that everyone try to limit themselves to one follow-up question to allow enough time for everyone to get their questions in during the allotted time. Now let me turn the call over to Tom for some opening comments.

Tom Lynch (Chairman and CEO)

Thanks, Keith, and good morning, everyone. If you turn the slide, I think it's slide three, that's a summary of our results. The company's off to a very good start in Q1. The majority of the markets we serve continue to improve, and we're executing well. The following are some of the key highlights of the quarter. Orders increased 8% in the quarter, and our book-to-bill was 1.03, excluding our SubCom business. This is the third consecutive quarter of organic orders growth, and this strength was broad-based across all regions and in the majority of our businesses. Organically, sales were up 7% overall and up 8%, excluding SubCom. The Transportation market continues to be very strong, and we're the clear leader in this market in capitalizing on this strength. Our Industrial markets and our telecom markets continue to improve in the quarter.

This more than offsets continued weakness in SubCom and Datacom. Adjusted operating margins were 14.6%, up 220 basis points over the prior year. Stronger revenue, productivity gains driven by our TEOA program, increased savings from restructuring, and metal tailwinds drove this improvement. We are on track to exceed 15% adjusted operating margins for the full year at a $14 billion sales level. Adjusted earnings per share of $0.82 was up 26% versus last year and $0.06 better than the midpoint of our guidance. Free cash flow was $266 million and puts us on track for another year of 10%+ cash flow as a percent of revenue. As a result of the strong Q1 and strong orders performance, we are raising the midpoint of our full year adjusted EPS guidance by $0.10 to $3.75. This is an increase of 16% versus our prior year performance.

Additionally, our board has recommended that at our annual meeting in March, our shareholders approve a 16% increase in the dividend. Please turn to slide four. This slide summarizes revenue by segment. I'll now go into each segment in more detail unless I indicate otherwise. All changes are on an organic basis, which reflects the effect of currencies, acquisitions, and divestitures. Please turn to slide five. We had another strong quarter in Transportation. Sales of $1.44 billion were up 14% over the prior year, and orders were up 13% with a book-to-bill of 1.02. Global auto demand continues to be strong, running a little ahead of historical long-term vehicle growth levels. Vehicle production in the quarter was about 20.8 million units, up 4% from last year.

Revenue from the heavy truck market was also very strong in the quarter due to the improving economy and the acceleration of purchases in advance of new emission standards in Europe and China. As I said last quarter, the Deutsch acquisition is really helping in this market. Revenue grew in all regions this quarter. Europe was up about 11% due to strong exports and slight improvements in local demand. We're encouraged by increased new car registrations across most of Europe in December, the first time it's been this broad-based in a while. We do believe pent-up demand and gradual improvement in the economy are driving this and expect to have another solid revenue year with our European customers. In the Americas, revenues were up 15% due to continued strong demand and share gains from our investments made during the downturn. We expect solid production growth to continue throughout 2014.

Asia revenues were up 17% with 30% growth in China and 27% in Japan. We expect to continue our momentum across Asia through the year. Our margin improvement was due to a combination of favorable mix with more heavy trucks in the Industrial Transportation market, stronger overall volume, productivity improvements driven by our TEOA program, and favorable metal costs. We expect another quarter of double-digit growth in Q2 and mid to high single-digit sales growth in the second half. Please turn to page six. Market demand in the Industrial Solutions segment continued to strengthen through the quarter, and our revenues were up 6% and orders were up 9%. This performance was in line with our expectations. Similar to last quarter, the Industrial Equipment, Commercial Aerospace, and Oil and Gas markets continued to have strong demand, and we expect this to continue for the balance of the year.

Our Energy business grew 4% in the quarter, but we do see signs of softening in the next couple of quarters, especially in Europe. We also believe the defense portion of our business should pick up a bit based on the resolution of the U.S. government budget. Looking forward, we expect another good quarter in Q2 with sales up about 6% due to the trends we discussed. Please turn to page seven. Performance in our Network Solutions segment was mixed in the quarter and overall in line with expectations. Sales of $713 million were flat versus the prior year. On the positive side, the Telecom Networks business grew 11% in the quarter, driven by increased investment in fiber optics networks. The Enterprise business was up 6% with growth in all regions. Offsetting that, our Datacom business was down 8%.

We are making progress in high-speed system wins, but we do continue to lag the market in mid and lower speed, which is where most of the volume is today. The SubCom market continues to be slow in projects going into force, but our backlog of awards continues to be strong. We still expect the business to pick up in the second half due to two new projects, which we expect to come into force this quarter. Margins in this segment were adversely impacted by two asset write-offs. Excluding these write-offs, adjusted operating margins were about flat with last year. We expect Q2 results to be up slightly versus Q1, and I would expect our normal seasonal second half pickup in this segment, in addition to an increase in SubCom revenues as these new contracts come into force.

Adjusted operating margins in the second half are expected to be back to double digits based on low double digits based on the expected volume increase. Please turn to slide 8. Revenue in our Consumer Solutions business was up slightly in the quarter. The overall trends in this quarter were similar to Q4 of last year, improving demand in the appliance market, declining PC demand, and strength in tablets and smartphones. We are capitalizing on the stronger appliance market where we have a leading market share. We've adjusted to the PC decline in our Consumer Devices business and are making gradual progress in smartphones and tablets. Adjusted operating margins in the segment were similar to the prior year. In Q2, we expect revenues to be down 3%-4% versus the prior year. However, adjusted margins are expected to be similar to prior year levels.

Now let me turn it over to Bob Hau to cover the financials in more detail.

Bob Hau (CFO)

Thanks, Tom, and good morning, everyone. A quick footnote to Tom's market comments: effective for the Q1 of fiscal 2014, we realigned certain businesses, principally the Relay Products business, within our segment reporting structure to better align our product portfolio. Approximately $100 million of annual revenue, which was previously reported as part of the Appliance business inside the Consumer segment, has been moved to the Industrial Equipment business in the Industrial segment. We've included a slide in the appendix of today's presentation, which provides the impact of each of the quarters of fiscal 2013 and 2012 for reference. Now let me discuss earnings, which start on slide 9. Adjusted operating income was $486 million, up 25% from the prior year. GAAP operating income was $479 million and includes $7 million of restructuring charges in the quarter.

As I mentioned on the earnings call in October, we anticipate a substantial reduction in the level of restructuring activity in fiscal 2014, with charges for the full year of approximately $50 million versus $311 million of charges in fiscal 2013. Adjusted operating margin was 14.6%, up 220 basis points from Q1 last year. The improvement is a continuation of the strong momentum that was achieved through the course of fiscal 2013. The change versus the prior year is driven by 7% organic sales growth, productivity from TEOA, cost savings from restructuring actions taken in the last couple of years, and favorable metals costs. Adjusted earnings per share were $0.82, and GAAP earnings per share were $0.85 for the quarter. GAAP EPS included $0.01 of restructuring and other charges and $0.04 of income related to legacy shared tax liabilities.

Turning to slide 10, our gross margin in the quarter was 33.6%. This is a 200 basis point increase versus the prior year due to volume increases, increased productivity from TEOA or lean programs, and cost savings from restructuring. Total OpEx spending was $631 million in the quarter, which was up 5% versus the prior year. The increase resulted primarily from increased selling expenses to support higher sales levels and increased variable compensation costs, partially offset by cost savings attributable to restructuring actions. On the right side of the slide, net interest expense was $29 million in the Q1, and I expect approximately $27 million of expense in the Q2 and similar levels through the remainder of the year. Adjusted other income, which primarily relates to our tax sharing agreement, was $7 million and in line with guidance.

In the Q2, I expect other income of about $6 million. The adjusted effective tax rate was 26.1%, which was higher than our guidance of 24%-25% due primarily to a one-time expense of approximately $10 million related to a change in tax laws in Europe. I expect the tax rate to return to the 24%-25% range through the remainder of the fiscal year. Turning to slide 11, I'll discuss our balance sheet and free cash flow. Cash from continuing operations was $387 million, and our free cash flow in Q1 was $266 million. Net capital spending during the quarter was $121 million, or about 4% of sales. I continue to expect capital spending rate to be approximately 4%-5% of sales for the full year. Receivable days outstanding were 62 days, which is down slightly versus the prior year.

Inventory days on hand were 74 days, consistent with prior year levels. Both metrics remain in line with our expectations. Now let me discuss sources and uses of cash outside of free cash flow shown on the right side of the slide. We began and ended the quarter with $1.4 billion of cash. During the quarter, we returned a total of $315 million to shareholders. We paid dividends of $103 million, and we purchased about 4 million shares for $212 million. We expect additional share repurchases of $150 million-$250 million per quarter during fiscal 2014. Our outstanding debt was $3 billion at the end of the quarter. Now I'll turn it back over to Tom.

Tom Lynch (Chairman and CEO)

Thanks, Bob. Please turn to slide 12, and I'll cover our outlook. As I said earlier, this was a very good start to the year for TE, driven by a strong Transportation market, continued improvement in most Industrial markets, and strong execution across the company. And order trends were strong in most of our businesses. Based on these trends, we expect Q2 revenue of $3.4-$3.5 billion, which is an organic growth rate of 5%-8%. We expect adjusted earnings per share of $0.88-$0.92, an increase of 16%-21%. In Q2, we expect another strong quarter in Transportation and a good quarter in the Industrial segment. Networks and Consumer results will be largely similar to Q1. For the full year, we expect revenue of $13.8-$14.2 billion, which is organic growth of 4%-7%.

We expect adjusted earnings per share of $3.65-$3.85, and this is an increase of 13%-19%, yeah, 13%-19%, and as Bob mentioned, a $0.10 increase in our guidance from last quarter for the year. Just to close, the momentum we saw in most of our markets in the second half of our last year has continued through the first four months of this year. These improving market conditions, coupled with our operating leverage improvements driven by TEOA and the accelerated restructuring last year, should enable us to deliver strong performance in fiscal 2014. Now let's open it up for questions. Operator, please.

Operator (participant)

Thank you. Ladies and gentlemen, if you wish to ask a question, please press star and then one on your touch-tone phone. You will hear a tone indicating you have been placed in the queue. You may remove yourself from queue at any time by pressing the pound key. Once again, if you do have a question or a comment, press star and then one. Our first question comes from Mike Wood, Macquarie. Please go ahead.

Shawn Harrison (VP and Senior Research Analyst)

Hi, thank you. Congratulations on the quarter.

Tom Lynch (Chairman and CEO)

Thank you.

Shawn Harrison (VP and Senior Research Analyst)

In terms of just some more color on the European growth on the Transportation side, it looks like you're forecasting 3% vehicle production growth for the full year next quarter. Recently, you've been exceeding that by a substantial margin in terms of your sales. You've mentioned exports. How much of that is actually related to any kind of pre-buy in the C&I side of the business in Deutsch related to the emission standard changing?

Tom Lynch (Chairman and CEO)

There's clearly some of that. Just to keep in mind, of our total Transportation, Industrial Transportation is in the neighborhood of 15%. So while it's definitely a good thing, it's not that much overall leverage on the segment. The European light vehicle market has, especially with the German OEMs, a significant amount of exports, and a lot of that is premium cars to the U.S. and China, where we have very nice content. So that helps offset what's been for several years now, weak local demand in Europe. But as I mentioned, we're encouraged to see over the last couple of months, and especially in December, a pickup in year-over-year new car registrations. It's not a long trend yet, but it feels like, and talk to our customers, it's moving in the right direction. So we expect another solid year with our European customers.

Shawn Harrison (VP and Senior Research Analyst)

Okay. In Datacom, you'd spoken previously about skipping a product generation there, moving too quickly to more advanced speed connector, but you were redesigning that 10-gigabit speed connector. How's that acceptance going? Are you just too late to kind of make traction in that particular product?

Tom Lynch (Chairman and CEO)

Well, I'd say we're doing well in high speed in terms of customers selecting us for next generation. It is going slower than we would have thought a year ago. And that whole market, if you watch the big equipment OEMs, there's a lot of dynamics in that market right now. And the net effect for us is the switch to new higher speed solutions is taking longer. So it's going to be, I think, a couple of years before we meaningfully move the meter in our Datacom business, given that. I mean, good product line, important product line to us, and it's also their products that ultimately move into other parts of our business down the road, but it's been slower than we would have thought for the reasons I said.

Shawn Harrison (VP and Senior Research Analyst)

Okay. Thank you.

Tom Lynch (Chairman and CEO)

You're welcome. Thank you.

Operator (participant)

Thank you. Our next question comes from Wamsi Mohan, Bank of America Merrill Lynch. Please go ahead.

Wamsi Mohan (Senior Equity Research Analyst)

Yes, thank you. Good morning. Which geographic regions did you see the strength in Industrial Transport? And Tom, even for that 15% of revenue that you're talking about, what sort of growth did you actually see in that part of Industrial Transportation? And I have a quick follow-up on margins.

Tom Lynch (Chairman and CEO)

Sure. The overall growth was well north of 10%. Very, very robust double digits. Again, some of that is pull forward. We did see very, very nice growth in China and Europe, solid growth in the U.S. What I would expect will happen is that'll moderate, especially in China and Europe where the new standards are being implemented. That'll moderate in the second half, but I would expect the U.S. to continue to improve as the economy improves.

Wamsi Mohan (Senior Equity Research Analyst)

Thanks, Tom. On margins, then, should we expect the margins to sort of play out at this level so maybe the mix becomes less of a benefit, but you continue to see volume growth as Europe improves through the course of the year?

Tom Lynch (Chairman and CEO)

Yes, Wamsi. That's a good way to think about it. We won't have as much favorable mix from the Industrial Transportation group. We will continue to see nice volumes and get the benefits of that. The metal levels, they've been pretty steady now for a couple of quarters. While there's year-over-year tailwinds kind of sequentially through the year, I wouldn't expect that. I would think of the Transportation business continued nice sales growth, really solid sales growth in this margin neighborhood.

Bob Hau (CFO)

Wamsi, I would expect that mix to moderate, which means the year-over-year margin expansion will slow. This quarter, we're looking at 440 basis points. We won't continue to see that, but we continue to see very good margins across the segment going forward.

Wamsi Mohan (Senior Equity Research Analyst)

Great. Thanks a lot.

Tom Lynch (Chairman and CEO)

Thank you.

Operator (participant)

Thank you. Next, we'll go to the line of Matt Sheerin with Stifel. Your line is open.

Matt Sheerin (Managing Director and Senior Equity Research Analyst)

Yes, thank you. Obviously, you've had nice margin expansion in Transportation, Industrial as well. But looking at the other businesses, particularly the computing or the Consumer business, what drives those margins? Is it volumes at this point? And looking within that business, I know you have some PC exposure. You talked about weakness there. It looks like demand is beginning to stabilize. And then also, in terms of your position on the mobility side, what's your outlook in terms of market share opportunities there?

Tom Lynch (Chairman and CEO)

So, Matt, regarding the margin question, and I think your characterization is accurate that we're in the Transportation and Industrial business. We're getting lift due to volume and productivity in the networks. And Consumer business, I feel good with the teams doing productivity-wise, but we're not getting the volume yet. Different reasons. Overall, in networks, we've got a very slow subcom business in the Datacom that I already talked to. In Consumer, while PC is hopefully the rate of decline will start to level off, which will help us. But we're making, let's say, slow, steady progress in the tablet and smartphone. It doesn't really have even though the product cycles are shorter than in the Industrial business, for sure, it's still you got to win one design at a time.

So until we begin to see our overall volume in Consumer Devices get consistently over 5% or 6%, that's what it's going to take to begin to move the margin up. In the Consumer solution segment, the Appliance business is a very nice margin business at about company average and starting to grow again with the improving economy.

Matt Sheerin (Managing Director and Senior Equity Research Analyst)

Okay. Great. And then question for Bob on the margins. In some of the commentary, you talked about some materials benefits, particularly metals. But could you talk about other things like copper and gold, for instance, and any tailwinds there in terms of margins and benefits on costs?

Bob Hau (CFO)

Yes. Overall, in the Q1, we did definitely see a tailwind of metals, which for us is really coppers, silver, and gold. There's probably about a $15-$16 million benefit in the quarter. For the full year, we're actually expecting about $50-$60 million. That quarterly $15-$16 million or so will remain in effect for the balance of the year currently.

Matt Sheerin (Managing Director and Senior Equity Research Analyst)

Okay. Thanks very much.

Operator (participant)

Thank you. We'll go to the line of Amit Daryanani with RBC Capital Markets.

Amit Daryanani (Managing Director)

Thanks, a lot. Good morning, guys. I have a few questions as well. Maybe start off on the Transportation side. For the last couple of quarters, and especially the December quarter, your business is up 14%. Production is up 4%. If I look at that 10% of outperformance, if I may, seems to be a lot more than just content growth or the Euro 6 mandate helping out. I'm curious, maybe you could talk about that 10%, how much do you think is content versus potential share gains versus new platform wins? I'm trying to get a sense of, can you sustain this kind of outperformance going forward?

Tom Lynch (Chairman and CEO)

Well, I think very strong performance for a couple of reasons. Some of it is mixed, again, with the Industrial Transportation business, where we have a very strong position as a result of combining Deutsch with our legacy TE Industrial Transportation business. And that business is growing much faster right now than the auto business, which is still growing. Light vehicles are still up +10% for us. In certain markets in China, in the US, we think we continue to gain share. We really invested, have invested in those markets, particularly during the downturn. And now that's starting to show up in our revenue. But I mean, I do think you'd expect to see us drop down to high single-digit growth in the second half of the year in the overall Transportation segment. But it feels like we've gained a little bit of share year-over-year.

Amit Daryanani (Managing Director)

That's helpful. And then just on the network solution side, demand has been, I guess, challenging for you guys for several quarters now. And if you think of the headwinds in Datacom and subsea really, do you think you have to look at options to potentially further right-size this business, or do you feel comfortable looking at a book-to-bill that demand will come back in the back half and you just got to wait for that revenue to flow in? I'm just curious how you think about right-sizing the business versus waiting for demand in the back half right now.

Tom Lynch (Chairman and CEO)

So I think there's two different answers to that. SubCom, I think we're well positioned. It's been slower than we thought. I'd be more worried if there wasn't as much project activity as there is. Those projects have to turn into come into force. So we feel reasonably confident, although this market has slid on us for the last two or three quarters. But we're very strong in the market. I don't think we've ever been stronger in terms of our product offering. So as that market comes back with our strength in it, we're confident we'll do very well. And we think we'll start to see that in the second half. Datacom's a little bit different. We're not strong in that market. We have done a lot to adjust our cost structure to reflect that without we haven't reduced our engineering investment.

And so we do have a significant engineering investment for high-speed type solutions there, both in fiber and copper. As I mentioned, they're going slower. We have no intention to take more cost out of the business. It's an important business for us. We believe it's really upside for us. But I think if you go back to where I thought would be a year from now, I thought there'd be more deployment of high-speed than there is. So it is definitely pushing out of the improvement in the business for us. But tweaking the strategy, yes, but no fundamental change to it.

Amit Daryanani (Managing Director)

Got it. Thanks a lot. Congratulations on a good quarter.

Tom Lynch (Chairman and CEO)

Thank you, Amit.

Operator (participant)

Thank you. Next, we'll go to the line of Shawn Harrison, Longbow Research.

Shawn Harrison (VP and Senior Research Analyst)

Hi. I'm going to beat networks maybe a bit. But even margins flat year-over-year, I would have thought with the metals tailwind, with a little bit of restructuring, you would have been able to do better. Is the margin in Datacom that much richer compared to everything else in the business? And so that, with Datacom being down so substantially year-over-year, explains kind of why margins would have been a little bit better?

Tom Lynch (Chairman and CEO)

There's a number of points, I think, Shawn, around all that. The telecom business is growing and improving. The subcom business is at one of the lowest points in the last six or seven years. So we're getting really zero leverage out of that business right now. And we think we're at the bottom, as I said earlier. The Datacom business, it's in a turnaround, really, for us. There's just no question about that. So it has the potential for high margins. We did write a few assets off in networks, which further took a low margin lower. But we think there's opportunity to improve it, but it's not going to be sudden. We're going to need more volume. I feel good about the cost structure because, as you pointed out, we did take cost out. We're just not getting the volume to take advantage of that right now.

But in telecom, we have a leading product line in fiber optics. In SubCom, we have a leading product line. In Datacom, we trail, although for the future, we have a good product line, but that's got to turn into reality. And in Enterprise, we have a solid product line. That business is historically a low-growth business. And we're right in there with that.

Shawn Harrison (VP and Senior Research Analyst)

Let's say I take an optimistic glass half full view and two years out, Datacom recovers. Is the margin profile in that business better than kind of the networking average, which should be mid-teens? And so you would get, I guess, a greater lift as that business accelerates. Is that what really needs to happen?

Tom Lynch (Chairman and CEO)

Yeah. We need more revenue, and we need particularly the industry to start moving to high-speed. When you dissect that business without getting into too much detail, the high-speed stuff is a loss leader. And our core business, while we're not a leader in mid-to-low-speed solutions, it's a solid business. We've been investing a fair amount in high-speed fiber and copper. And so with very little revenue in there, it has the effect of exacerbating the margin in a downward way in that business.

Shawn Harrison (VP and Senior Research Analyst)

Okay. Just as a brief follow-up, Bob, I think last quarter it was $60-$70 million in restructuring savings that were supposed to benefit the model this year. Did that change?

Bob Hau (CFO)

We're actually seeing slightly better than that. Right now, restructuring is a little bit closer to $70 million-$80 million.

Shawn Harrison (VP and Senior Research Analyst)

Then the aggregate number of $100 million, did that change at all?

Bob Hau (CFO)

No. A little north of that, which is what we were saying previously.

Shawn Harrison (VP and Senior Research Analyst)

Okay. Thanks so much, and congrats on the quarterly guidance.

Bob Hau (CFO)

Thank you. Thanks, Shawn.

Operator (participant)

Thank you. We'll go to the line of Jim Suva with Citi.

Jim Suva (Managing Director)

Thank you. Congratulations to you and your team there on good results. A quick financial question for Bob, and that's on restructuring, followed by a more fundamental question probably for your team. I think you'd mentioned that restructuring looks like it's going to be coming down lower this year. Can you help us quantify that a little bit more? I think you gave a little bit of numbers there. And is that then a recurring rate sustainable with that, or are we kind of looking at a lower rate one time this year? And if so, it appears like this rate could be so low, are we looking at folding it into your normal operations? For the more operational question, when we look at content growth for vehicles, I think in the past you gave some commentary of kind of long-term 6%-8%.

With cars going more and more into hybrid and safety and emissions always continuing to improve, is there a chance that that 6-8 actually starts to increase or goes to the higher end or even above the higher end of that? Thank you.

Bob Hau (CFO)

Yeah, Jim, it's Bob. On the restructuring, we spent about $7 million this quarter, roughly in line with what we anticipated. Previous guidance and still guidance today is about $50 million on a full-year basis. That's down dramatically from prior years. Last year, we spent just north of $300 million. We think ongoing natural restructuring charges of a business of our size, given the nature of our markets and then customers, it's probably $50-$75 million. So we're a bit below "normal" right now, but it's largely given the amount we spent last year. As we've said before, we talked a little bit about in our investor day, we are looking at ways to fold it in. I think it's important to describe it and disclose it externally, whether investors dial it out or roll it back in. It's up to them. We'll give them the information.

One of the big reasons that we still have today adjusted earnings versus GAAP earnings is we're still dealing with the tax sharing agreement pre-split, and some of those numbers can move significantly. It would be very disingenuous to only talk about GAAP earnings. But we certainly look to, a, settle in the tax sharing agreement over the next couple of years and be much lower restructuring charges.

Tom Lynch (Chairman and CEO)

Hey, Jim, on your other question, we've typically talked about content of 4%-6%. And I do think that there's more likely for that to go higher than lower. That's the way I would say. And I walked around in Detroit last week and walked through the auto show, and you can feel it. I mean, we obviously see it in our business, and it's our biggest business.

But when you see 100 cars on the floor and you contrast them with the features they have versus their prior iteration of a particular model, you can feel it. So I do think it's more likely to go up slightly than down. It goes at a metered pace just because of the product cycles, and it doesn't happen overnight to design new features. But it's a really good trend, and it's why we're excited about the business so much. Also, historical production rates have tended to be 2%-3%. We think for the next few years, or the industry, I should say, thinks that could be up 1 point, 1.5 points. And that's with a very, very low growth in demand for local demand in Europe. So I think most of the trends are positive.

In China, you have dealers starting to finally expand in the tier 3 to 6 cities. So we expect to continue to have a robust automotive market there. So the combination of more likely upside in production than downside versus the historical rate and more likely upside in content than downside, I think makes this a very attractive market for many, many years.

Jim Suva (Managing Director)

Great. And I think I got my numbers of the 4%-6% as content growth, and 6-8 is then when you add on the global SAAR or the global units of auto production. And so 6-8 is what the sales rate is in content of 4-6. Is that kind of what you're seeing?

Tom Lynch (Chairman and CEO)

Yeah, that's what we're seeing. And of course, netted into that is price, which is moving up a little bit. But as you can see in our margins, we're able to give the customer the price that they need and keep the margins moving in the right direction.

Jim Suva (Managing Director)

Great. Thank you. Congratulations again to you and your team.

Operator (participant)

Thank you. Next question is from Mark Delaney, Goldman Sachs.

Mark Delaney (VP)

Great. Thanks very much for taking the question, and congratulations on a strong quarter. I understand on the margins, there's been a tremendous amount of year-over-year improvement in the adjusted operating margin, 14.6% this December quarter versus about 12.5 the year prior. I'm hoping you can help me understand within the March quarter guidance, maybe the bridge from last year. And so specifically, by my math, the March quarter implied operating margin guidance is right around 15%. And then the revenue level at the midpoint is pretty similar to the revenue that you guys did for the September of 2013 quarter. I would think that there's maybe some metal pricing benefits versus the September of 2013 quarter and then some restructuring benefits that are coming through.

Given that you did the 15.7% in September quarter, I'm just trying to hope you can walk me through how you're thinking about getting to the 15% or so in the March quarter of fiscal 2014.

Tom Lynch (Chairman and CEO)

The way I'd describe it, Mark, is continued steady volume growth where we'll get the lift there. The metal difference isn't that much from two quarters ago. It's been a nice tailwind, but it's not that much incremental. We are investing more. There's no question. So we believe continuing to strengthen the product line and just continuing to invest in emerging markets and engineering and selling. So we are continuing to invest. But overall, we'd expect to continue to drive the margin up. And we're pleased with the productivity. Price erosion is up a little bit, not dramatically, but there's no question that as typically happens with particularly copper hanging around at this rate for a while relative to where it was 18 months ago, that customers are expecting appropriately some of that back. So we have pluses and minuses, but net-net, very good momentum in the margin.

Mark Delaney (VP)

Understood. Thank you for that. For my follow-up question at the analyst day, Tom and Bob, you guys talked about looking at doing more acquisitions, I think maybe on the tuck-in type of size. Can you give us an update on how that's progressing?

Tom Lynch (Chairman and CEO)

Well, we did the two big ones, and we've been continuing to build our pipeline, especially focused in anything related to Transportation and the broader Industrial markets. So we keep plugging away there. It's an active pipeline. We're always talking to people, but we're thoughtful about it. Got to, number one, really fit strategically. And obviously, we've got to be able to create value with it. But we expect it to be an important part of how we grow the company on an ongoing basis. But we feel good about the organic momentum, particularly obviously in Transportation and Industrial. And we have to continue to get it going in the other two.

Mark Delaney (VP)

Understood. Thanks. And congratulations again on a good quarter.

Tom Lynch (Chairman and CEO)

Thank you, Mark.

Operator (participant)

Thank you. Next, we'll go to the line of William Stein with SunTrust Robinson Humphrey.

William Stein (Managing Director)

Morning. Thanks for taking my question. I'm hoping you can clarify the comments about the changes in demand in the automotive end market related to the new emission standards. I assume you're talking about Euro 6. Can you clarify whether that relates to light cars or heavy trucks and verify your comments about pull-in in light cars to get ahead of this rollout?

Tom Lynch (Chairman and CEO)

Yeah. Well, let me.

I'm glad you asked. So I can clarify. It's really in the truck market primarily. So that's where we see what looks like accelerated demand to get the older version trucks because the new ones are more expensive. Not an unusual thing in this market. It's not the major thing driving it. We believe just improving economic environment plus the age of the trucks on the road are an even bigger part of that. But clearly, for the first half of this year, the very high growth rates in the Industrial Transportation, which is only 15% of Transportation, are being driven by our customers ordering earlier.

William Stein (Managing Director)

Great. That's helpful. If I can ask one follow-up, I'm hoping to hear a bit about demand and inventories in the channel relative to your direct business.

Tom Lynch (Chairman and CEO)

Sure. The channel was a little bit slower in December than we expected. Still a solid business. But we did see the kind of really not unusual calendar year-end inventory tightening. Not a big number and not different from our expectations, kind of in line with our expectations. But when you look at it more sequentially from our Q4 into the Q1, definitely a little bit softer because of adjustment. But don't see any overhang or anything like that out there in talking to our distributor partners.

William Stein (Managing Director)

Great. Thank you.

Tom Lynch (Chairman and CEO)

Thanks, Will.

Operator (participant)

We have a question from Sherri Scribner, Deutsche Bank.

Sherri Scribner (Director and Senior Sell-Side Equity Research Analyst)

Hi. Thank you. I just wanted to dig a little bit into the improvement you're expecting in the second half of the year in the networking and Consumer business. I know you talked about some orders that you're anticipating, and it sounded like you're expecting some additional strength in the SubCom market. So I was just hoping for a little more detail on the strength in the networking piece in the second half of the year.

Tom Lynch (Chairman and CEO)

Networks will typically have a seasonal piece. In telecom, especially primarily in telecom, as the weather gets better, we see the business pick up. We're really in that business pretty much looking for a similar pickup, first half, second half that we saw last year. Subcom is much more related to contracts coming into force. The big thing is we're counting on two contracts to drive that. We've got the contracts, signed the contracts, all that. We would expect that they'll go into force. But until they do, anything can happen. That's the big thing driving networks. In Consumer, it is a little more of continuing to gain traction. In appliance, I would say if the economy continues to improve, that business naturally follows the economy. That's less seasonal and more economic related.

Consumer, of course, has its peaks in the quarter or the quarter and a half before the Christmas season. But we're not looking for anything dramatic in the second half in the Consumer business. I mean, relatively, that's a small business for us. So relatively, it's nice. But absolutely, in terms of its effect on the overall company, it's kind of a penny a quarter, I think, Bob, in that range. So it's not a big lever. We're trying to make it a bigger lever.

Sherri Scribner (Director and Senior Sell-Side Equity Research Analyst)

Okay. Then based on the guidance, if I do the math, it looks like at the midpoint for your fiscal 2014 guidance at $14 billion in revenue, your operating margins are somewhere around 15.5%. I know you've said that you could do +15%. But are you comfortable with sort of a 15.5% operating margin for the year that suggests some decent operating margin leverage in the second half?

Bob Hau (CFO)

Yeah, sure. At midpoint of that $14 billion, the operating margin's about 15.3%. Yes, we're comfortable with that given the progress we saw really through much of last year and into Q1 around overall benefits of our lean initiatives, what we call TEOA, as well as the improved benefits from restructuring in the metal tailwind gives us confidence of that 15.3%. I think that generates the $3.75 earnings at midpoint.

Sherri Scribner (Director and Senior Sell-Side Equity Research Analyst)

Okay. Is that assuming the SG&A is relatively flat from Q1 levels, or do you see some declines in that based on the productivity improvements? Thanks.

Bob Hau (CFO)

Overall for the year, SG&A is about 13.5% sales.

Sherri Scribner (Director and Senior Sell-Side Equity Research Analyst)

Okay. Thanks. Thanks.

Bob Hau (CFO)

Thanks, Sherry.

Operator (participant)

Thank you. We have a question from Steven Fox, Cross Research.

Steven Fox (Managing Director)

Thanks. Good morning. Just going back to the operating margins for a second. If I look at the Transportation and Industrial margins, it seems like there was a greater drop-through effect on both sides of the business on a quarter-over-quarter basis. So on the positive sales from Transportation, you pulled down a greater-than-average drop-through, and the reverse was happening on Industrial. Can you just sort of break down how much more was related to metals in those segments versus I don't believe there was a lot of restructuring, but what else was driving that? Because I'm just having trouble footing those numbers. Thanks.

Bob Hau (CFO)

And Steve, I think I'd point to two things. Number one, better volume, better revenue lift in those two segments until you get the benefit of the volume leverage into our factories. Then from a metal standpoint, in particular relative to networks, the other three segments have much more metal content. So you see that $15-$16 million year-over-year benefit really layered into the other three segments where networks doesn't participate. All of our business is clearly involved in TEOA and lean, but there's a significant extra lever when you get the volume leverage. What I'd add when you compare auto or Transportation to Industrial as well is there's sales per part in Transportation higher. So that's a higher volume business than Industrial. So you're not going to typically have the same fall-through.

Tom Lynch (Chairman and CEO)

But we feel in the Industrial business overall, there's nice opportunity to do fundamental margin improvement through TEOA. We're further along with that in Transportation than we are in Industrial. So we expect to see the same kind of improvements.

Steven Fox (Managing Director)

Great. That's helpful. And then just quick follow-up on China, Tom. Given how fast it's growing, could you just talk a little bit about within the China market, especially on the auto side, where you think you're picking up share from a content standpoint? Is it helping or hurting the overall content growth for the company within auto, given the mixed differences, and why you think you're picking up that share a little bit more? So will be helpful. Thanks.

Tom Lynch (Chairman and CEO)

Sure. Thanks. Well, I think the momentum piece is, I mean, we've been in China a long time. I mean, our whole team is local. So we have a very, very strong seasoned team that is a local team that's been in the business a long time that's been developed by our other teams around the world. So we have a lot of know-how there. We work with every customer. We bring to bear the technologies from the other parts of the world. We're as strong with the local customers as we are with the multinationals. While the content per vehicle in the locally produced cars is less, it's rapidly rising at a greater rate because in order to compete in that market, you have to have the features that the multinationals have.

I think while the overall content per vehicle in China is less than it is in Germany, for sure, it's rising at a faster rate. And in China, for the local customers, we provide in some cases a much broader product range than we do other places because the customers need the expertise. So that has helped us that four or five years ago, we decided to kind of get. I don't want to say services in the sense that we charge for services because we don't really do that. But we help a lot in the design of the electrical system for the local customers because they wanted to help. So that's helped us. That's helped us a lot. And you just see the continued expansion and especially demand for high-end cars.

So while the low-end car overall, there's a lower content, you're selling a lot of premium cars, particularly from Germany, into that market where we have a significant content.

Steven Fox (Managing Director)

Great. That's very helpful.

Bob Hau (CFO)

I guess.

Steven Fox (Managing Director)

Yes. Thanks very much. I appreciate it.

Tom Lynch (Chairman and CEO)

Thanks, Steve.

Operator (participant)

Thank you. Our last question comes from the line of Amitabh Passi from UBS.

Amitabh Passi (Senior Technology Equity Research Analyst)

Hi. Thank you, Tom. I had a question and then a follow-up. I guess the first one was just a big picture question. It seems to me when you embarked on the ADC acquisition and Deutsch, part of the motivation was to sort of diversify your growth drivers and your portfolio. Yet if I look at the numbers today, about almost 45% of your sales are coming from Transportation and about 60% of your EBIT dollars. So just curious, as you look at your portfolio, and I know you touched on this, but would like to get more details, is there an appetite maybe to accelerate the inorganic element to continue to sort of balance out the portfolio both from a growth and profitability perspective?

Tom Lynch (Chairman and CEO)

Amitabh, I'd say the underlying strategy of Deutsch was harsh environment. So our sweet spot, what we're best at, and where we think the most value we can add and the most value we can extract is in the really harsh environments. And so I'm not worried at all about the Transportation business getting bigger if it's for natural reasons, right? The market's growing. We're strong. We do well there. The customers really value the full value proposition we bring. We can support them in every part of the world. I think the Industrial business benefited from Deutsch too. So half of the revenue that came from Deutsch, half went into Transportation, half went into our Industrial Solutions business in Mil-Aero, which now we have almost a $1.1 billion business as a result of that acquisition.

And again, enabling us to do other things that we wouldn't have otherwise done because of the breadth of the product line. So if you think of us, we like the harsh environment. And that's what we're best at. We're clearly better at it than we are in Consumer. Consumer and Datacom and networks are important to us. And we think we have a lot of value to add there. But we're not really on a strategy to try to lessen our participation in Transportation because if you just look at the underlying trends there, it's just more content, and there's still a long way to go. So we want to continue to be strong there. And of course, we want to the way I'd characterize our four businesses, Transportation is a great business, and we're really good at it.

Industrial is a good business, and we're good at it with the opportunity to be better. Network Solutions, kind of mixed, a solid business. We believe the fiber part is a really good business to be in because of the bandwidth demand, and we're good at it. And Consumer, we're getting better, but we're not good. And we have a terrific team in there that's changing it. So we view that as opportunity, selective opportunity, as we said. So that's how we think of the portfolio. And we think all four of the segments need to have the right attention in order to be successful. So we're not really trying to deemphasize Transportation.

Amitabh Passi (Senior Technology Equity Research Analyst)

Okay. Perfect. And then just as a quick follow-up, I'd like a little more insight into the Telecom Networks piece of Network Solutions. You grew almost 11% year-over-year. I think you're guiding to 5% growth. Verizon seems to be sort of deemphasizing investments in wireline. NBN was the hot topic two years ago, kind of fizzled out. So just as you look at project activity, which areas and regions are you most excited about? And why, after growing 11% in the Q1, do you still think it's a mid-single-digit growing segment this year?

Tom Lynch (Chairman and CEO)

Yeah. I mean, I think 11% was driven very strong by some wins in South America, some accelerated activity in Europe. We expect those to level off. There is uncertainty around NBN. It's still in an early stage, far enough that I don't think anybody's going to turn back. But there is a question of how deep will they drive the fiber. It probably won't be everybody gets fiber to the home, but it's going to be fiber deep, which is still a really good business. If you go back to the prior quarter, it was a different part of the world. The important thing, the encouraging thing, but we need to see it quarter after quarter after quarter, is there's just more projects. So as I think I said at investor day, there's a lot more projects in the last year than there were the year before that.

But it tends to be a lumpy business. Our fundamental belief is that when you model data flow, you've got to have the fiber network deeper than it is. You don't have to go fiber to the home to give the Consumer a good experience, but you need to have fiber getting the offload, even from an LTE network, deeper than it is generally in the network around the world, which is why we think it's a 5%-6% growth business over time. But it does take fortitude to ride through the cycles. And last year, we took a lot of cost out to make sure that whatever cycle it is, that we're solidly above cost of capital kind of return. So that's how we see it right now. We don't expect 11% growth over the balance of the year.

Shawn Harrison (VP and Senior Research Analyst)

Okay. Got it. Thank you so much and good luck.

Tom Lynch (Chairman and CEO)

Thank you. Okay. Well, thank you very much. And for those of you like us who fought through the snow to participate, we appreciate it. Again, a good quarter. And more than anything, I think it reflects a lot of the actions we've taken over the last several years. Certainly, it's very nice to see general economic improvement. We're not giddy about that, "Hey, all of a sudden, we're in a high-growth area." We continue to be focused. And we look forward to talking to you in a not-too-distant future. Thanks for joining us.

Operator (participant)

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