TE Connectivity - Q2 2016
April 20, 2016
Transcript
Operator (participant)
Ladies and gentlemen, thank you for standing by, and welcome to the Q2 earnings call. At this time, all participants are on a listen-only mode. Later, we will conduct a question-and-answer session. The instructions will be given at that time. If you should require assistance during the call, please press star and then zero. As a reminder, this conference is being recorded. I'd now like to turn the call over to our host, Mr. Sujal Shah. Please go ahead, sir.
Sujal Shah (Head of Investor Relations)
Good morning, and thank you for joining our conference call to discuss TE Connectivity's second quarter results. With me today are Chairman and Chief Executive Officer; Tom Lynch, President; Terrence Curtin and Acting Chief Financial Officer; Mario Calastri. During the course of this call, we will be providing certain forward-looking information. We ask you to review the forward-looking cautionary statements included in today's press release. In addition, we will use certain non-GAAP measures in our discussion this morning. We ask you to review the sections of our press release, the accompanying slide presentation, that address the use of these items. Press release and related tables, along with the slide presentation, can be found on the investor relations portion of our website at te.com.
Finally, for participants on the Q&A portion of today's call, I would like to remind everyone to limit themselves to one follow-up question to make sure we are able to cover all questions during the allotted time. Now, let me turn the call over to Tom for opening comments.
Thomas Lynch (Chairman and CEO)
Thanks for joining us today, and please turn to slide three, and we will review the highlights from today's call. Q2 was another quarter of good execution in what continues to remain a sluggish global economic environment. Adjusted earnings per share of $0.90 was $0.02 cents better than the midpoint of our guidance on sales of $2.95 billion, which were slightly below the midpoint of the guidance. Strong operating performance across the company more than offset continued market softness across our industrial businesses. Our adjusted earnings per share was down 1 penny versus the prior year, with foreign exchange headwinds of approximately $0.02. On a constant currency basis, adjusted EPS was up 1% year-over-year. Adjusted operating margins were 14.9%, in line with our expectations, with adjusted EBITDA margins of approximately 20% in the quarter.
For the full year, we are reiterating the midpoint of our guidance of $12.3 billion in revenue and $4 in adjusted earnings per share, representing an increase of 11% over prior year EPS. We expect to return to revenue growth in the second half and to generate double-digit EPS growth. Our outlook for organic growth is 3%, down slightly compared to our guidance of 90 days ago. Our auto business remains solid, the industrial inventory correction is largely behind us, and SubCom continues to build momentum. Our recent acquisition of Creganna is now in our guidance as well. These positive factors are offsetting lower-than-expected growth in most industrial markets and slow growth in our non-transportation business in China. Our EPS growth is benefiting from cost controls, the benefits of our share buyback, and a bit of a lower tax rate.
We have developed multiple levers to drive earnings growth in a slow economy. During the quarter, we returned $1.2 billion to shareholders, including $1.1 billion in share buybacks. We expect to continue to take a balanced approach with our capital strategy, returning approximately two-thirds of our free cash flow to shareholders over time, with one-third of free cash being used for acquisitions. We generated $165 million of free cash flow in the quarter and $400 million in the first half of the year. We expect our normal strong second half cash generation to continue. We also continued to strengthen the company's harsh environment portfolio. In March, we completed the sale of our circuit protection business.
Earlier this month, we completed the acquisition of Creganna, doubling the size of our medical business to about $500 million in revenue and establishing TE as a leading provider of solutions to the high-growth minimally invasive medical market. This morning, we also announced a small sensor acquisition, which will strengthen our portfolio of sensor technologies serving the transportation markets. In our SubCom business, we continue to gain momentum with the recently announced award of a project called Hawaiki, which is a new transpacific cable system linking Australia and New Zealand to the mainland United States. This award will generate over $200 million in revenue over the life of the project, and this business has a backlog of awarded projects of $1 billion. I'll now turn it over to Terrence Curtin, who will cover our performance in more detail.
Terrence Curtin (President)
Thanks, Tom, and good morning, everyone. Before we get into the segment updates, I want to provide brief insights into our order patterns, which will help provide a baseline for our results as well as the expectations. If you could turn to slide four, please, and this shows order trends excluding our SubCom business. Overall, orders improved again sequentially and are above the low levels of approximately $2.6 billion that we experienced in the fourth quarter of 2015. And if you remember, in the fourth quarter of last year is when we began to experience the supply chain impacts related to the slowing in China, as well as the industrial markets. We have seen recovery in orders in both of these areas and feel that the supply chain correction effects have completed in our second quarter as we expected...
Certainly, we're pleased with the recovery in the orders. However, the slope of the recovery is running behind original expectations in certain areas. Specifically in China, we previously thought that orders would continue to accelerate through the rest of the year. While we believe the auto orders in China will continue to recover, we are now expecting orders outside of auto to sort of remain at the current levels that we're experiencing in the second quarter. Let me now talk about the orders by segment. Overall, transportation orders remain solid, and in auto, our orders were negatively impacted by a near-term customer backlog adjustment that related to a change in their scheduling. I want to highlight, this does not impact demand. It's really just a change in one of our customers' processes. We continue to experience strong order trends, both in Europe and in Asia, in automotive.
In industrial, orders grew 5% sequentially, with growth in both our direct customer orders as well as those that go through our channel partners in distribution. As I stated earlier, the industrial inventory correction is now behind us. In communications, excluding SubCom, our orders grew 4% sequentially, with a book-to-bill of 1.05, with improvement in both our appliances and data device businesses. As Tom mentioned, in SubCom, it continues its momentum with the new Hawaiki program, and we will record that order as a booking in our third quarter. If you could please turn to slide five, I'll discuss Transportation Solutions results in the second quarter. Overall, sales grew 3% in the segment organically in the quarter, with growth across all our businesses. Our auto sales growth in the quarter was driven by strength in China as well as in Europe.
For fiscal 2016, we continue to expect global auto production to be up 2%-2.5%, with growth in all regions and strong growth in China. We remain confident that our auto business can grow ahead of auto production, driven by electronic content growth, as well as a rich pipeline of platform ramps from design wins that were generated over the past several years. In commercial transportation, sales grew 1% organically year-over-year, driven by the heavy truck sector in both China and Europe. North America heavy truck markets continue to remain weak, along with continued weakness in global construction and ag markets. We're pleased that organic orders were up both year-over-year as well as sequentially, as we continue to perform very well in this business in a tough economic backdrop.
Turning to sensors, we saw 2% organic growth as we did begin to feel the impact of weakness in the industrial markets in our sensor business. Just to highlight for you, about 40% of our sensor sales go into the industrial markets. We do continue to see strong design momentum in long cycle transportation and industrial applications that we expect will drive future growth. From a margin viewpoint, adjusted operating margins in the segment were 19%, and we're in line with our expectations, and we're up sequentially. The decline year-over-year was driven by currency impacts as well as investments for growth. We anticipate adjusted operating margins for the second half to continue to improve and should be at similar levels as the second half of last year. If you could please turn to slide six, and I'll discuss the Industrial Solutions segment.
Revenue in the segment declined 7% organically year-over-year in the second quarter. Geographically, we continue to see trends across our businesses that are consistent. Europe is stable and growing in many markets. North America continued to see weakness due to oil and gas, as well as the supply chain corrections that impacted us the past couple of quarters, and China remains sluggish. We continue to be impacted by the oil and gas market, which saw a 42% organic reduction in sales year-over-year, and the decline in oil and gas drives half of the organic decline in the segment in the second quarter. Low oil and gas prices continue to have a derivative effect in other areas of the industrial segment, including factory equipment as well as in helicopter demand, which affects our aerospace business.
We have included the impacts in our results as well as in our guidance. In aerospace and defense, our commercial aerospace business grew year-over-year, and this was more than offset by declines in the defense business due to supply chain effects that were occurring in the distribution channel. Our energy business was down 2% organically, with declines in Asia and in Europe, partially offset by growth in the U.S.. As we look forward, we expect the industrial segment to grow sequentially, and we expect it to be essentially flat organically year-over-year in the third quarter, and we expect it to return to growth in the fourth quarter now that the inventory corrections are behind us. Adjusted operating, excuse me, adjusted operating margins were down year-over-year, driven primarily by declines in the higher-margin oil and gas business, but they were up sequentially.
We do expect adjusted operating margins to continue to improve in the second half, benefiting from the increased volumes as well as the cost actions that we've initiated. If you could please turn to page seven to talk about the communication segment. In the second quarter, the segment had revenue of $606 million, which was down 10% and 8% organically year over year, and it was slightly ahead of our expectations. Our SubCom business saw solid year-over-year growth, driven by strong execution from multiple projects in force. And as Tom mentioned earlier, the total value of programs in force is approximately $1 billion. We now expect SubCom to grow approximately 20% year over year, and this is an improvement versus our expectations 90 days ago.
Our data and devices and appliance businesses were impacted by distribution inventory corrections, as I mentioned earlier, and we believe these are behind us as we head in the second half of the year. Additionally, data devices growth is impacted by the product exits we've been highlighting all year as part of the repositioning effort, and as discussed, will impact our growth rate throughout this year. Adjusted operating margins in the segment declined 60 basis points year-over-year, in line with our expectations, and we do expect improvements to adjusted operating margins as we continue through the second half. Now let me turn it over to Mario, who will cover the financials.
Mario Calastri (Acting CFO)
Thanks, Terrence, and good morning, everyone. Please turn to slide eigth, where I will provide more details on earnings. Adjusted operating income of $440 million was in line with guidance and down 13% year-over-year due to currency impacts, investments in transportation, and the lower volume impacts that Terrence mentioned earlier. GAAP operating income was $535 million and included $4 million of acquisition-related charges and net restructuring and other credits of $99 million, primarily driven by a gain on the sale of our circuit protection business. Adjusted EPS was $0.90 for the quarter, down $0.01 from the prior year, with reduced volume from higher-margin products and negative impacts from currency exchange rates, offsetting incremental benefits from share buyback. Excluding the $0.02 impacts from foreign currency, adjusted EPS was up $0.01 from the prior year.
GAAP EPS was $1.06 for the quarter, driven by net restructuring and other credits of $0.17, primarily due to the circuit protection sale I just mentioned. We expect approximately $100 million of restructuring charges for the full year, a $50 million increase from prior guidance. Regarding tax, you should continue to think of TE's long-term adjusted tax rate at approximately 23%-24%. Due to the mix of profitability in different jurisdictions, we now expect our adjusted tax rate to be slightly lower this year. As we mentioned last quarter, Tyco International, on behalf of TE, entered into an agreement with the IRS to resolve all disputes related to the previously disclosed intercompany debt issues.
During the quarter, we made net pre-separation tax payments to the IRS of approximately $140 million to prevent further accrual of interest and penalties, and hope to have this settled and behind us in the near future. As you may know, the Treasury Department issued proposed tax regulations earlier this month. One proposal addresses the tax characterization of certain intercompany financing arrangements. Like most multinational companies, TE utilizes intercompany financing for efficient capital deployment. We are in the process of analyzing these proposed regulations for any potential prospective impact on TE. Turning to slide nine, while we remain in a challenging environment, our performance was in line with our guidance, and we expect improvement across our operating metrics in the second half. Our adjusted gross margin in the quarter was 32.6%.
The decline from last year is mostly driven by lower volume in areas like oil and gas and distribution, which have higher margin than company average. Adjusted operating margins declined 150 basis points, consistent with our gross margin performance. Total operating expenses were $523 million in the quarter, down 5% from the previous year, reflecting strong spending controls. We continue to tightly manage discretionary spending while balancing our continuing investment into our harsh businesses. Moving to cash flow and capital deployment, in the quarter, cash from continuing operations was $155 million, and our free cash flow was $165 million, down from prior year levels due to timing of certain tax payments, but still up in the first half versus last year.
We expect full-year free cash flow to approximate $1.9 billion. We continue to have a balanced capital allocation. In the second quarter, we returned $1.2 billion to our shareholders, including $1.1 billion in buybacks. The quarter, we bought back 19 million shares, executing against our commitment of returning the proceeds from the broadband networks divestiture. Over the past 18 months, we have returned approximately $4.3 billion to our shareholders through buybacks and dividends. As Tom mentioned earlier, we expect to continue to take a balanced approach with our capital strategy going forward. We're also including a chart on Adjusted EBITDA margins, which helps explain the profitability performance of our businesses, including acquisitions. Adjusted EBITDA margins in Q2 were 20% and show our margin resiliency despite lower sales levels.
Continue to be pleased with the operating performance of our business, especially in light of the challenging macro environment. We've also added a balance sheet and cash flow summary in the appendix for additional details. Now, let me turn it back to Tom.
Thomas Lynch (Chairman and CEO)
Thanks, Mario. Before I get into Q3 guidance on slide 10, let me provide some perspective on why we will return to growth in the second half. As you know, our first half was characterized by several year-over-year macro headwinds: unfavorable foreign exchange due to the significant strengthening of the dollar against most major currencies. The significant decline in year-over-year oil prices, which resulted in an over 40% decline in our high-margin oil and gas business. Overall, industrial markets weakened, leading to a supply chain corrections with OEMs and our channel partners, which we believe are now behind us, and weakness across most China markets. In the first half, these factors impacted us significantly, and in the second half, most of these headwinds are reduced.
As a result, we expect to return to revenue growth and strong double-digit adjusted EPS growth, driven by our harsh strategy and the many levers in our operating model. Now I'll cover the Q3 outlook. We expect Q3 revenue of $3 billion-$3.2 billion, up 1% on an actual basis and flat organically, and adjusted earnings per share of $1-$1.06, up 14% year-over-year at the midpoint. We expect growth in transportation and industrial, which includes approximately $60 million from the Creganna acquisition. This is offset by declines in communications from the sale of the Circuit Protection business and the continuation of our strategy to exit certain product lines in Data and Devices. We do expect continued growth in our SubCom business. Now, please turn to slide 11.
We are reiterating our full-year guidance of $12.3 billion in revenue and $4 in adjusted EPS at the midpoint. On a full-year basis, continued strong performance of our Transportation segment, the addition of the Creganna acquisition and growth in our SubCom business, more than offsetting the negative impact of exchange rates and softer industrial markets, especially oil and gas in China. As mentioned earlier, the full year and fourth quarter includes the 53rd week, which contributes approximately $200 million of revenue. Now, this full-year outlook includes an unusually high Q4 revenue and EPS level compared to Q3, so I'll walk you through that. As previously mentioned, this year's fourth quarter includes an extra week, which contributes approximately $200 million of revenue and approximately $0.10 per share in earnings. Excluding the 53rd week, revenue is increasing approximately $40 million from Q3 to Q4.
So the way to think about this is the $240 million revenue will flow through to earnings at a 25%-30% rate, and this, coupled with our typical productivity, accounts for the significant sequential increase in EPS. Let me just wrap up with a few comments. As we mentioned earlier, the global economic environment continues to be sluggish. Despite this, we expect to generate another year of solid performance. Our focus on harsh environments, driving TEOA through the organization, strong cash flow, and a consistent return of capital policy, continues to enable us to significantly strengthen our earnings leverage. A dollar of revenue today generates about 40% more EPS than five years ago. This is serving us very well in a slow-growth economy and will deliver accelerated earnings growth as the global economy improves. So now let's open it up for questions.
Sujal Shah (Head of Investor Relations)
Thank you, Tom.
Operator (participant)
Thank-
Sujal Shah (Head of Investor Relations)
Brad, could you give the instructions for the Q&A session?
Operator (participant)
Certainly. Thank you. And ladies and gentlemen, if you do wish to ask a question, please press star and then one on your touch tone phone. You'll hear a tone indicating that you've been placed in queue, and you can remove yourself from the queue by pressing the pound key. If you're using a speakerphone, please pick up the handset before pressing the numbers. Again, it's star one. And we'll go to the line of Amit Daryanani with RBC Capital Markets.
Amit Daryanani (Managing Director and Equity Analyst Enterprise Systems and Hardware and Electronic Supply Chain)
Yep, thanks a lot. Good morning, guys. I guess two questions for me. Tom, maybe carrying on what you saw at the end of the call with the September quarter guide.
... You know, historically, I think in September, revenues seem to be down a little bit sequentially, 2% by my math. So could you maybe talk about what gives you the comfort that sales could be at $42 million sequentially on an organic basis? And then on the EPS line, I guess the same thing, you know, the extra week gives you $0.10, the $40 million would give you another $0.02-$0.03. I still struggle to get the entire $0.20 that you guys are implying for September.
Thomas Lynch (Chairman and CEO)
Hi, Amit. I think there's a little static on the line. Try to get through this. Yeah, normally, if you go back over many years, we've had a few years where we're up slightly in the fourth quarter, a few years where we're down slightly. I mean, last year was a pretty unusual year because that is where China and the industrial inventory correction really began to occur. This year, the pattern coming into the fourth quarter is different. We have industrial markets improving. We have China, while not quite as much as we thought, improving. For sure, the auto market is improving as we expected. So that's really the difference, accounting for a slight sequential improvement as opposed to, you know, what we could say over time has been kind of a flat two, three, four.
We also pick up, when you add $240 million in revenue, sequentially, a lot of leverage comes with that. So that's how you, I think, will for sure be in that 25%-30%. The restructuring that's been going on through the year continues to flow in and aggregate, so there'll be a better benefit in Q4 than Q3. And then our normal productivity momentum, which marches through the year. So when you, when you add all that up, you know, that's how you get to what looks like a pretty significant hockey stick. But when you peel it back and say, "It's a small hockey stick.
Amit Daryanani (Managing Director and Equity Analyst Enterprise Systems and Hardware and Electronic Supply Chain)
Fair enough. That, that's helpful to kind of get the levers there. And then I guess just the transportation segment, I think you guys actually took up the production or unit expectation up modestly for autos. But the organic growth, I think, went from high single digit to mid-single digit. Could you just talk about what are the variables that's leading to, to the lower organic growth within transportation for the year?
Terrence Curtin (President)
Hi, Amit, it's Terrence. Two things. We did not change our auto production estimate. We've been around that 2%-2.5% since last quarter, and really, that is China being, you know, middle to higher single digits, Europe being, you know, about 1%, U.S., about 4%. So that's... We have not changed those assumptions. When you look overall at the transportation organic growth, primarily driven by the comments I made around sensors, we did reduce our expectation for the year around sensor organic growth, really related to the impact of the industrial markets. So the growth we had there was lower this quarter than we thought, and we are seeing order impacts due to some of the industrial impact that we've seen elsewhere on the sensor business.
Amit Daryanani (Managing Director and Equity Analyst Enterprise Systems and Hardware and Electronic Supply Chain)
Perfect. Thank you, guys.
Thomas Lynch (Chairman and CEO)
All right. Thanks, Amit. Can we have the next question, please?
Operator (participant)
One moment. That'll come from the line of, excuse me, Wamsi Mohan with Bank of America.
Wamsi Mohan (Senior Equity Research Analyst)
Yes, thank you. Good morning. Terrence, you pointed out strength in autos in Europe and China. I was wondering if you could talk about the order patterns in North America and auto. Are you seeing any signs of deceleration in auto patterns that is concerning to you at this point? And I have a follow-up.
Terrence Curtin (President)
Wamsi, thanks for the question. So the one up comment I made around the backlog adjustment, that was in our U.S. business, but that was really scheduling change by a customer. That did not have anything to do with demand. What we have seen in North America, we have seen some leveling of order patterns, is how I would describe them. I wouldn't say there's an acceleration or a deceleration outside that specific adjustment with that customer, but otherwise, I would say a leveling.
Wamsi Mohan (Senior Equity Research Analyst)
Okay, great. Thanks. And as my follow-up, transportation margins saw a year-over-year decline, despite organic growth of 3% and reported flat. Can you address what the moving pieces are? I think you called out FX and some increased investments. What are those increased investments, specifically, if you could give any color on that? Thank you.
Terrence Curtin (President)
When you look at those increased investments, you know, we've had a tremendous amount of program wins, both in our sensor business as well as in the automotive business. As you know, they're long cycle businesses, Wamsi, so we have been putting investment in to support those programs. So it's mainly in engineering and product launch teams, both in sensors as well as core automotive, around those program launches that'll benefit us in future years.
Thomas Lynch (Chairman and CEO)
Okay. Thank you, Vamsi. Can we have the next question, please?
Operator (participant)
That'll come from Sherri Scribner of Deutsche Bank. Please go ahead.
Sherri Scribner (Director and Senior Sell-side Equity Research Analyst)
Hi. Thank you. I wanted to get a sense of what drives your confidence that the industrial segment will improve in the back half of the year. It sounds like you think China's gonna be relatively flat, but potentially, I think you're saying that the inventory situation is better. So just trying to understand what makes you comfortable that things will get better in the second half. Thanks.
Thomas Lynch (Chairman and CEO)
Sure. Thank you. I'll comment, and then I'll have Terrence add to it. I think a couple things. One, when we look at inventory in the supply chain, both at our direct customers and our channel customers, it feels like that's back in balance right now. And that's what our channel partners feel as well. So that's... You know, when the business started to go a little bit flatten out last year, the supply chain adjusted negatively, so we've been going through that. We do see China gradually picking up, so... It really began to turn down in the second half of last year and in the fourth quarter of last year. So some of that is a compare. I don't think we're predicting... We're not predicting a robust industrial market.
It's really things getting more in balance, and then we'll have the benefit of the Creganna acquisition segment. So Terrence, you wanna add some more color to that?
Terrence Curtin (President)
No, I think, Sherry, Tom said it very well. The last year in, in the fourth quarter is when oil and gas, as well as a lot of the channel and inventory effects hit us. So in some ways, it's a weak compared to the fourth quarter last year on an organic basis, but we do see them leveled out. I think the third quarter, as we talk about it, being flat year-on-year, I do think the industrial world is relatively flat right now. So I think we're getting those supply chain effects behind us, anniversarying oil and gas, as well as, you know, CommAir, we continue to expect to be a very strong market. And then Tom mentioned medical for Gana.
Sherri Scribner (Director and Senior Sell-side Equity Research Analyst)
Great, that's really helpful. And then can I just ask a quick question on the communications, margins? They were down year-over-year, and I would have thought maybe would have been a bit stronger given the subsea business is higher. How should we think about the subsea business impacting that margin as we move through the year as revenue is stronger? Thanks.
Thomas Lynch (Chairman and CEO)
Subsea, yeah, you know, communications, as you know, is a mix of kind of three businesses, a very good appliance business, the subsea business that is growing. And the first quarter margins were very high because we had the close out of a job in subsea that we expected to take a couple more quarters, and that really popped the margin in the first quarter. The second quarter is more normalized for subsea, so I expect subsea will gradually improve. The data and devices margins will start to improve later this year, but we're feeling more optimistic about that. We did, you know, we're taking the circuit protection out. That was in the second quarter, but that is not in the balance of the year.
So when you go business by business, Appliance, strong margin, steady, SubCom, take the first quarter out as a little bit of an aberration, growing as volume grows, and Data and Devices poised to start improving next year based on what we see right now.
Terrence Curtin (President)
Okay, thank you, Sherri. Can we have the next question, please?
Operator (participant)
Thank you. And that'll come from the line of Craig Hettenbach with Morgan Stanley.
Craig Hettenbach (Research Analyst)
Great, thanks. Question on Creganna, understanding it just closed, but if you could just give some anecdotes in terms of customer engagement, number one. Number two, just kinda, you know, what that does for you more broadly in, in kind of the medical opportunity set?
Terrence Curtin (President)
Yeah, sure, Craig. It's Terrence. The reaction from the customers have been very positive. Certainly, we made the first move in this space last year with AdvancedCath, and I think the customer reaction of having both of these together and to get bigger scale in a space where, like we said, it's about a $3 billion market, of which, you know, we're basically a number two player right now in that, customers have really appreciated. So that, that's a real positive. I think secondly, as we talked about, to the second part of your question around what does it do? What's really nice about what Creganna does for us is really rounds out the portfolio. So just to remind everyone, you know, it gets us to about 90% of that integrated solution of what we'll have internally.
I think the other thing that is very powerful, not only their position and their engineering, but where it's positioned in the world, really balances out our medical product platform, and they fill it not only with manufacturing, but with the engineering, and fill the gap we had around Europe with their strong Irish presence. And then clearly, bringing in 225 engineers that know that space, knows those applications, really doubled our engineering capability. So really feel we have a very nice platform to continue to build upon. And, you know, very, very early, but very excited about it as well.
Thomas Lynch (Chairman and CEO)
The one thing I would add, Terrence, is we complement Creganna in China. With our size in China and, you know, our robust platform across China and an existing medical business there, and that market is made to order for minimally invasive because you have a growing, a huge population, an aging population, and you don't quite, you know, have the affordability. So this, we're really excited about helping them scale much faster than they would have normally been able to in China.
Craig Hettenbach (Research Analyst)
Got it. Thanks. And then, and then as my follow-up on the tuck-in announcement this morning, you know, if I look back to MEAS, they did a number of tuck-ins and many deals to kind of build the base that you have today. So just your strategy in the sensor market, it feels like that's a market that's very fragmented. There's a lot of growth, there's a lot of opportunities, but could we expect more along these lines in terms of you doing these type of $40 million-$50 million type revenue deals?
Terrence Curtin (President)
Craig, I think you said it very well. The number one is it's a very fragmented market, and what we liked about what was announced today with Jaquet, really is this is a speed sensor that product company that really plays very strongly into transportation, both in the industrial transportation side as well as automotive and the turbocharger applications. So I think when you look at the sensor space, you'll continue to see us do things similar to this as we continue to build out the portfolio and build on what both Mesh has and what we had historically, and continue to grow this business. So very excited about the business we announced last night, and it'll help strengthen us in the transportation space.
Craig Hettenbach (Research Analyst)
Got it. Thanks for that.
Thomas Lynch (Chairman and CEO)
Thank you, Craig. Can we have the next question, please?
Operator (participant)
That'll come from Shawn Harrison with Longbow Research. Please go ahead.
Shawn Harrison (Senior Research Analyst)
Hi, morning, everybody.
... What about just the buyback, just to be clear on the math, is there about $1.1 billion now available on the buyback? And should we assume the June quarter gets you back to the normal cadence of, say, $150 million-$250 million type of activity?
Mario Calastri (Acting CFO)
Hi, Sean, this is Mario. We still have actually about $1.3 billion of debt. You know, just a reminder in terms of what we talked about in the comments, our strategy remains very much consistent with the past, and a reminder of what we have accomplished in the last 18 months. Then Tom is gonna add anything.
Thomas Lynch (Chairman and CEO)
Sure. I would say, yes, we're gonna get back probably to the lower end of the normal range in the next couple quarters. You know, we bought back $3 billion over the last nine months. We did make the Creganna acquisition, and but we feel this 2/3, 1/3 split really works for us. We haven't seen anything that changes our view, that from a strategic point of view, that's the sensible capital allocation. And as you know, all of you have been following us for a while, there's periods where it's a lot higher than two-thirds return on capital, and then there's periods where we make any kind of sizable acquisition where it dip below that.
Shawn Harrison (Senior Research Analyst)
Okay, that's helpful. As a follow-up, just on auto in general, maybe it's a two-parter. Have you seen any impact from the earthquake in Japan? I think Toyota was give or take around a $500 million customer, if my notes from 2011 are correct. Then just also on what you think the impact of China's stimulus is on the business this year, and how, you know, that could affect the business rolling into fiscal 2017.
Terrence Curtin (President)
Hey, Sean, it's Terrence. Thanks for the question. I think first of all, let's take Japan. What I would say of Japan, I think your sizing of Toyota is about right. When you sit there and you think through the earthquake in Japan, clearly that's a fluid situation that we're monitoring with our customer. You know, we have not seen any disruptions yet. We're sort of assuming normal pattern, but where we see demand at, it may impact some timing a little bit, but we're talking to our customers constantly and making sure we're helping them any way they can as they work through, you know, that tragic event in Japan.
On China stimulus, I think that's a little bit more of a complicated question, that when you look at it, you know, we did get impacted in our first quarter as, you know, China's overall production adjusted, so we talked about that. What we have seen is China coming back to about a 6% production environment year post that, which is pretty much in line with GDP. I don't think we know whether the, China stimulus accelerated some production or demand, but we do sort of view that China production long term will stay around GDP of China. So I don't think we're far off right now. I think we'll have to see as the stimulus works off, if there's any timing effects. But right now, we feel pretty good as production has restimulated post the first quarter being very slow for us.
Thomas Lynch (Chairman and CEO)
Okay, thank you, Sean. Can we have the next question, please?
Operator (participant)
Mark Delaney with Goldman Sachs, please go ahead.
Mark Delaney (Analyst)
Yes, good morning, and thanks very much for taking the questions. The first one's a follow-up on the Q4 guidance. I know you talked about some of the top-down factors that you're thinking about in terms of the different end markets. Can you help us understand, is there anything that you're getting from specific customer forecasts that are giving you a lot of visibility that Q4 is up sequentially from Q3? It's just, you know, anything on the kind of lead times. I thought they're normally four to six weeks, so it seems like it's more top-down driven. But if you have a bottom-up reconciliation that that's giving you more confidence, that'd be helpful, I think.
Thomas Lynch (Chairman and CEO)
So we have a lot of customers, so there's a lot of data points. I would say the biggest indicators are just on one hand, what we said in industrial. So we do see that sequential growth in orders, and it's continued into April, pretty solidly, so that gives us confidence. It doesn't... You know, it's not a slam dunk. The channel partners all pretty much back to a positive book-to-bill, seeing POS in line, you know, with increasing demand and reflecting inventory levels in the channel back in line. So those are all positive indicators. And if you recall, at this time last year, those indicators were starting to... You know, they were raising caution flags. They're going the other way. So that's what's given us some optimism. Again, we're not expecting a boom from Q3 to Q4.
I think it's just where the cycle is this time versus prior years. And of course, got to always keep reminding you of that extra week. You know, it's confusing to all of us, but yeah, there's an extra week there. So when you strip that out, we're talking about $40 million in revenue pickup. But right now feels, you know, we think that's balanced. I mean, you know, we'll know a lot more at the end of the third quarter, but when we look at what the channel pattern is versus prior years, when we look at our industrial businesses' orders sequentially and seeing it both in the OEM customers and the channel customers, that's what gives us that confidence. Terrence, you wanna? Did I miss anything there?
Terrence Curtin (President)
No, I think you said it very well, Tom.
Mark Delaney (Analyst)
Okay, I appreciate the additional color there. And then follow-up question on the tax rate commentary and kind of actually a two-parter. So I think 23%-24% was the comment. What sort of effect should we expect for the potential settlement around the old Tyco liabilities? Should we be looking for on the other income line? Are there changes there? And then, can you just clarify, does the long-term guidance of 23%-24% include what you think a potential impact might be around earnings stripping regulation, or you just haven't had a chance to better put that into numbers yet?
Thomas Lynch (Chairman and CEO)
... Yes, to, to answer the question, I, I think that what, what we talked about, in, in the comments, our expectation for the longer term remains at 23%-24%. That does not include any implications around regulations, 'cause it's really too early to, talk about any potential impact there. We're still looking at it. And, and when it comes to the, second half, we do expect it to be a little bit lower than the 23%-24%. And that's mostly driven around, distribution of profitability around jurisdiction, more than, more than expectation around, 7.
Okay, thank you, Mark. Can we have the next question, please?
Operator (participant)
Go to the line of William Stein with SunTrust. Please go ahead.
William Stein (Managing Director and Senior Analyst)
Great. Thank you for taking my question. I'm still having trouble understanding your comments about the transportation segment. I think that you noted that automotive is at least as strong as it looked previously, and that the downward adjustment to the full year guide in that segment is related to the sensor business. So it sounds like you're seeing industrial sensor applications roll off just at the same time that you expect the rest of the industrial exposure to start to improve. So maybe you start by reconciling that, and then I have a follow-up, please.
Thomas Lynch (Chairman and CEO)
Yeah. Let me start with that. I think, Will, on the way to think about the sensor piece of that is growth is slowing, whereas in the connector part of the business, growth was down, right? Because of inventory correction. So, now we expect what's gonna happen in the second half of the year in the industrial connectivity business, flat, and then a little bit of growth in Q4. But sensors is a different story. It's just really growth slowing, reflecting, you know, this uncertainty out there. Terrence, you wanna talk more about transportation?
Terrence Curtin (President)
Yeah. No, Tom, you said it well. I mean, when you think through the interconnect piece of industrial, about 50% of it goes through distribution, in sensor is very little done. So what we've seen is we've actually seen our sensors industrial actually come down and slow more like our direct customers. So Tom, Tom is very much right on it. And the rest of it, transportation, Will, it is like we said in the comments, we see the production environment staying steady at a 2%-2.5% growth. Certainly, China being the big driver of it, Europe being up slightly. So we see that continuing to be solid. And transportation, when you say it's down a little bit, really has to do with that sensor problem. Over to Tom.
William Stein (Managing Director and Senior Analyst)
So the follow-up there is that, within transportation, sensors is still quite small. It's, I don't know, 10% or 15% of the total transport. And I suspect that what's really driving the full year difference is some... You made a comment on the prepared remarks around a supply chain or some other inventory adjustment that one of your customers is making in North America. Can you help us? We're really trying to understand is this, it, you know, what's going on here, and is this sort of a valid read as to what's going on in the industry, or is this particular to TE, and is it very temporary and then snaps back, or is there a bigger problem here? Thank you.
Terrence Curtin (President)
Oh, Will, it is actually just how customer schedules orders into it. They changed their process, so it does affect the numbers. It does not affect demand. And that did impact our orders, but it is not impacting the demand we're seeing from customers. So really, it's just their process of how they gave orders. They've changed to a more real time in giving us a firm, full-out calendar view of it, and that adjustment impacted our orders, but it doesn't impact the demand patterns at all. It's just how we do business between the two companies.
Thomas Lynch (Chairman and CEO)
What I would add, Will, is just to help, you know, help the understanding of it here, is our automotive business will grow more in the second half than it does in the first half. So we're not. You know, the mixes are changing, you know, North America plateauing a bit, China picking up, Europe steady. But when you, when you step back to your question, "Hey, is there something going on here?" We actually are gonna have a stronger auto business in the second half than the first half. The overall sensor business growth rate, lower in the second half than the first half.
Terrence Curtin (President)
Yeah, I would just... One last comment, Will. Yeah, in that 2%-2.5% production environment, we do expect to be in the high single digits in our automotive business.
William Stein (Managing Director and Senior Analyst)
Thank you.
Thomas Lynch (Chairman and CEO)
All right. Thank you, Will. Can we have the next question, please?
Operator (participant)
That'll come from Steven Fox with Cross Research.
Steven Fox (Managing Director)
Thanks. Good morning, two questions from me. First off, just getting back to the transportation margins. I understand the investments that are going on. I'm just curious if you can just give us some bigger picture comments on how you're managing those against, you know, our own short-term expectations for margins in that segment versus what's an expanding opportunity for growth. And then I had a follow-up.
Thomas Lynch (Chairman and CEO)
Sure, so I'll disaggregate for a moment. You know, the three pieces of our transportation segment, automotive, as Terrence said, very strong business. Expect to grow mid- to high-single digits on 2%-3%, 2.5% production growth. Margins there remain strong. Sensors is below the transportation averages, as you know, with the acquisition, with tremendous opportunity to move those margins up. And we are investing at a—we're increasing our R&D investment at a faster rate than our sales growth in sensors because the opportunity is so great. And customers absolutely like another strong, resilient, technology-rich company providing sensors into the transportation market, and we are getting significant design-ins, and that requires engineers. It's been our plan from day one when we made the acquisition.
And then in the industrial transportation business, which is the highest margin business in the group, we are now, I think we're navigating very well, maintaining our margins in a, in a very, almost really negative growth environment. Our growth is up because of our strong position in China and Europe, which is offsetting North America. So we, we really, within the segment, we, we manage those businesses separately based on the dynamics and the opportunity. And as Arun said in his comments, we're, you know, we're pretty confident that you'll see the margins improve again sequentially. They went up 40-50 basis points, Q1 to Q2.
We expect that margin to continue in the second half of the year with a little bit of volume growth over the first half of the year, because there's a lot of operating leverage in those business.
Steven Fox (Managing Director)
So just to push back on the second point around sensors. So is it safe to understand then that this was sort of an unusual quarter in terms of the investment levels versus revenues actually ramping with some new programs, and that gap starts to close going forward, or does it stay at these levels for a little while? If you could sort of qualify that. And then my follow-up question was just to get an update on the CFO search. Thanks very much.
Terrence Curtin (President)
Sure, Steve. So it is ramping. You know, we, we began increasing our sensors investment late last year. And certainly, as we win programs, we talked about the design wins, especially in longer cycle businesses, there will be a gap. So I don't think it's an anomaly, but it's something where we have to invest ahead in as we win these programs. So it is a ramp, that you're gonna see in sensors. But we always expected that, as we build the business.
Thomas Lynch (Chairman and CEO)
One more comment before I address the CFO search. I think it's really important, you know, if you look at the transformation of the company to harsh environment, out of businesses that don't fit that definition, and you know, for us, that's highly engineered, high barriers to entry, the capital allocation strategy. You see how that enables us, even in a slow growth market, to make strategic investments in something like sensors, which is gonna be a big business for us. And, so yeah, we have decided not to really change our strategy there, given that we have all these other levers to drive the earnings growth that we set out six months ago, you know, $12.3-$12.4 billion in revenue and $4 EPS.
So, that's part of the story, too, an important part. On the CFO search, we're active, as you can imagine. We have several internal candidates. We're going through the external candidates. Obviously, a critically important job. What I feel good about is we have a very strong financial organization across the company, and the team is doing great. Mario has stepped in, and you can tell in an effective way. He's been with us 10 years, knows us very well and from all dimensions. But yeah, that's an every day item on our list, and I would expect in the next couple of months, we'll be you know, making some announcements.
Steven Fox (Managing Director)
Great. Appreciate the call.
Thomas Lynch (Chairman and CEO)
Perfect. Thank you, Steve. Can we have the next question, please?
Operator (participant)
Thank you. That'll come from Jim Suva with Citi. Please go ahead.
Jim Suva (Managing Director)
Thank you very much. When you mentioned on the prepared remarks, as well as a little bit on the Q&A about your automotive customer changing its supply chain a little bit, can you give us some details, like, did you benefit from that in the prior quarter? Or it sounds like this quarter, you had some weakness associated with that. Do you then, in the future, recoup that weakness? Because it seems like at the end of the day, the supply chain has to all connect itself. Was that change, you know, I assume, led by the customer, and is it then going to be rolled out globally to them or already has it? Was it centered around petroleum, or diesel, or electric, or HV?
Or how should we think about kind of what's going on there, and is this a rippling change to the industry? Then my second question or the follow-up would be on the intercompany debt. I know you mentioned that the past historical IRS settlement is in the works, and you're accruing the interest for it and so on and so forth. Am I also correct to say that the new regulations also potentially and/or do impact your current debt structure amongst the company? And if so, can you quantify or let us know about anything around that? Or was it all just simply backward stating and going forward, there are no considerations? Thank you.
Terrence Curtin (President)
So on the first part... I'll take the first point, and I'll take, or Mario take the second point. Number one, it's at a customer, so when you look at programs and things like that, Jim, you can't really look at them. They changed their process. So certainly, this was something that built up over time, the way they did the process. They gave us very forward-looking orders that we recorded as orders and backlogs. Now they've moved to be a more current JIT, which the way I would articulate it, that scheduling came out, and they're gonna hit us with orders more frequently. That does create a de-booking in our world. It does not impact the programs that we've won with that customer.
... throughout the world. So when you look at it, it is something that is very process-centric. It does not impact programs, and you can't get it into individual, you know, diesel versus electric versus combustion engine. It, it isn't there. And over time, we'll just get those orders in more frequently than having a scheduled back order. I'll let Mario turn over to the sector piece on your tax question.
Mario Calastri (Acting CFO)
Sure. On the tax question, first of all, on the settlement, we did mention that we have made a prepayment to the IRS that effectively stops the accrual of interest on that liability, which basically takes out most of the impact of the settlement when we will actually settle. So we already have included in our guidance the fact that we have made that payment that impacts our tax rate. On the second element, as far as the regs that are put in place, first of all, those regs, those proposed regs are prospective, so they do not have any impact on our current intercompany debt position. And again, it's a complicated matter that we are getting our head around.
But no, there is no impact to our current intercompany debt position. That would be only prospective.
Jim Suva (Managing Director)
Great, thank you very much.
Terrence Curtin (President)
Thank you.
Thomas Lynch (Chairman and CEO)
Okay. Thank you, Jim. We have the next question, please.
Operator (participant)
Thank you. That'll come from Mike Wood with Macquarie. Please go ahead.
Mike Wood (Analyst)
Hi, good morning. Thanks for squeezing me in. Realizing that your visibility is very good on the auto platforms, can you just give us your incremental enthusiasm or concerns over just where, you know, your share will be moving over the next several years? And has there been any platform wins on the passenger vehicle side from Measurement Specialties?
Thomas Lynch (Chairman and CEO)
Yeah, sure. Thanks. Yeah, I mean, geez, I couldn't. I have to contain my optimism around the automotive business, globally. You know, with our presence and our range of technology, it's becoming more and more important. You know, we have a significant share in the connectivity business. But over the last five years, we believe we increased that five points. That, that is quite an accomplishment, and it, it, it really is. As these solutions get more complex, and all you have to do is kind of look under the hood and see how different it is over the last five or six years, the connectivity and the sensing solutions are more complex.
On the connectivity side, we continue to win at a rate faster than we have in the past, which is why I think we've said a few times, if you, if you go back 5 years and we talked about a 2%-2% production environment, we would have talked about a 3%, 3%-4% revenue to TE environment. Now, we believe that's 5%-6%, and that's, that's just really more market share than it is content. So I, I expect, you know, we'll continue to inch up our market share because of the range of capability we have. And just, for example, hybrid electric vehicles, the difference in our designing in rate in the last 3 years versus the first, the prior 5 years is 2-3x.
So as that market now, you know, continues to pick up, we have a high content, and we're extremely well positioned with all the leading platforms. You know, feel good about that. On the sensor side, we have won significant design-ins with the MEAS technology and our go-to-market and our, you know, the strength we bring and the credibility we bring to an auto customer. You know, we're an auto supplier through and through and been doing that for 50 years. And so they like the technology, and they trust us, and we're winning important awards. They're not showing up in revenue yet, and that'll be in the next couple of years.
But that's why when we talked earlier, incredibly enthusiastic and shielded, actually ahead of the hypothesis we had with Mesh about our ability to bring their technology into the auto market, which is the best market for sensors. Eric, you want to add anything to that?
Terrence Curtin (President)
No, I think Thom just said it well. And then also, you know, even with the small acquisition, it, you know, continues to give us confidence that we're able to leverage our go-to-market in the transportation area, like Tom said. So I think our program wins we've been getting, the other thing that's nice about them, they are on all geographies of the world. It's not just concentrated in one geography, which actually leverages that great go-to-market that we have in our auto business that we always talk to you all about.
Mike Wood (Analyst)
Great. And as a follow-up, on the industrial orders, can you just give us the breakout of the OEM trend versus the distributor order trends in the quarter?
Terrence Curtin (President)
Yeah, sure, Mike. Just let me grab it quick. When you look at it, the trend in the quarter between the two that you had, what we saw on the OEM side, year-over-year was relatively flattish. And then on the channel side, we were still down year-over-year. But what's nice is it, it was getting back to where last year's quarter levels were, which gives us confidence that when we get to the third and fourth quarter, our channel sales versus last year will be up because we did have that correction in the fourth quarter. The other thing that Tom mentioned that I think is important, our channel partners have seen positive POS. They are seeing a book-to-bill greater than one.
So it's not only our order patterns, and as we talk to our channel partners, they have also seen their book-to-bill go back above one, as well as positive POS. So it's a combination of those factors.
Mike Wood (Analyst)
Great. Thank you.
Operator (participant)
Thank you.
Terrence Curtin (President)
Okay, thank you, Mike. We have the next question, please.
Operator (participant)
Thank you. That'll come from Mark Delaney with Goldman Sachs. Please go ahead.
Mark Delaney (Analyst)
Appreciate you taking the follow-up. Just follow up on the tax rate question. Once the Tyco liability is settled, should we be thinking about the other income from Tyco and Covidien going to zero? So, you know, tax rate 23%-24%, but assume no other income from that going forward.
Mario Calastri (Acting CFO)
Mark, sorry, let me, let me clarify. The way you should think about it is that the settlement is gonna be, basically EPS neutral, and there's going to be a swivel between the other income that's gonna go away and the tax rate that's gonna get lower. Now, at this point, the guidance and what we talked about, the 2023 to 2024 and being a little bit lower in the second half, does not include the settlement. So we're just not including the settlement in that guidance. But you should think about it as EPS neutral because we have done the prepayment to the IRS, so we basically stopped the accrual on these.
Mark Delaney (Analyst)
Thank you.
Terrence Curtin (President)
Okay, thank you, Mark. We have no further questions, so thank you very much for your time this morning.
Thomas Lynch (Chairman and CEO)
Thanks, everybody.
Please contact Investor Relations at TE. Have a great day.
Mark Delaney (Analyst)
Thank you, everyone.
Operator (participant)
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