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Edited Transcript of TEL earnings conference call or presentation 28-Apr-20 12:30pm GMT

Q2 2020 TE Connectivity Ltd Earnings Call

SCHAFFHAUSEN May 6, 2020 (Thomson StreetEvents) -- Edited Transcript of TE Connectivity Ltd earnings conference call or presentation Tuesday, April 28, 2020 at 12:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Heath A. Mitts

TE Connectivity Ltd. - Executive VP & CFO

* Sujal Shah

TE Connectivity Ltd. - VP of IR

* Terrence R. Curtin

TE Connectivity Ltd. - CEO & Director

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Conference Call Participants

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* Amit Jawaharlaz Daryanani

Evercore ISI Institutional Equities, Research Division - Senior MD & Fundamental Research Analyst

* Bharat Daryani

JP Morgan Chase & Co, Research Division - Analyst

* Christopher D. Glynn

Oppenheimer & Co. Inc., Research Division - MD and Senior Analyst

* Craig Matthew Hettenbach

Morgan Stanley, Research Division - VP

* David Jon Leiker

Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst

* David Lee Kelley

Jefferies LLC, Research Division - Equity Analyst

* Deepa Bhargavi Narasimhapuram Raghavan

Wells Fargo Securities, LLC, Research Division - Associate Analyst

* Francisco Javier Amador

Cowen and Company, LLC, Research Division - Associate

* Jim Suva

Citigroup Inc, Research Division - MD & Research Analyst

* Joseph Robert Spak

RBC Capital Markets, Research Division - Analyst

* Mark Trevor Delaney

Goldman Sachs Group Inc., Research Division - Equity Analyst

* Matthew John Sheerin

Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Senior Equity Research Analyst

* Nikolay Todorov

Longbow Research LLC - Analyst

* Shawn Matthew Harrison

Loop Capital Markets LLC, Research Division - MD

* Wamsi Mohan

BofA Merrill Lynch, Research Division - Director

* William Stein

SunTrust Robinson Humphrey, Inc., Research Division - MD

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Presentation

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Operator [1]

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Ladies and gentlemen, thank you for standing by, and welcome to the TE Connectivity Second Quarter Earnings Call for Fiscal Year 2020. (Operator Instructions) As a reminder, today's call is being recorded.

I would now like to turn the conference over to your host today, Vice President of Investor Relations, Sujal Shah. Please go ahead.

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Sujal Shah, TE Connectivity Ltd. - VP of IR [2]

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Good morning, and thank you for joining our conference call to discuss TE Connectivity's Second Quarter 2020 Results. With me today are Chief Executive Officer, Terrence Curtin; and Chief Financial Officer, Heath Mitts.

During this call, we'll 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.

(Operator Instructions)

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

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Terrence R. Curtin, TE Connectivity Ltd. - CEO & Director [3]

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Thank you, Sujal, and thank you, everyone, for joining us today to cover our second quarter results, insights around what we're seeing in real time and how this is expected to impact us as we look forward.

We are all living through a challenging environment brought about by the global COVID-19 pandemic. When we had our last earnings call just 90 days ago and provided our outlook, it was before the initial onset of COVID in China, and we did not include any expected impact in our quarter 2 guidance.

I'm very pleased that despite the impacts, we were able to deliver the results in line with the expectations and meet the commitments we made to our customers as well as our shareholders during the quarter.

Now before I get into the results, I do want to thank our employees. As you all know, we are a global company with engineering and manufacturing operations around the world, and the safety of our employees has been primary concern. I would like to express my gratitude and appreciation to our teams for their dedication as we navigate the COVID-19 crisis and continue to effectively serve our customers as they also were trying to figure out how to navigate this crisis.

A few things that I think stand out in our response to this crisis. First, as a company, we were able to prioritize the safety of our employees while demonstrating strong execution with our customers. Our engineering, customer service and other nonmanufacturing teams adapted well to remote and online work to ensure innovation and service to our customers. I also believe we demonstrated operations resiliency. In China, we brought back our plants online relatively quickly, considering the environment and steadily increased utilization levels to minimize the impact in the quarter. All of our factories are open and running in China, and Heath will highlight where we are in manufacturing in Europe and North America in his section a little bit later.

And lastly, I believe we demonstrated agility, and it gives us confidence about our ability to continue to adapt to changing conditions. Our employees have been extraordinary in supporting our communities, customers and each other. And what I've seen in the past few months gives me confidence in our position coming out of this crisis. We'll talk more about what we expect over the next few months, but I am proud of the performance, resilience and flexibilities of our team in this quarter.

So if you could, let me start talking about results, and they'll begin on Slide 3, and I'll frame out the key points of today's call. We delivered sales that were in line with our guidance and adjusted earnings per share that was above the high end of our guidance range with strong performance across all 3 of our segments. Adjusted operating margins were above 16% and reflect the diversity of our portfolio and the early execution of cost reduction actions, placing TE in a position of strength at a time of continued uncertainty.

Another key point is that our balance sheet is strong, and we have ample liquidity. A key part of our business model is a strong free cash flow engine that is resilient in periods like this. We expect to generate well in excess of $1 billion of free cash flow this year, and we also have $2.3 billion of liquidity available.

Also, as we look forward, there is limited visibility of future demand. We do expect to see greater COVID-19-related impacts in our business in the second half with particular market weakness in transportation as well as in the commercial aerospace market. As a result, we are estimating that our sales could be down approximately 25% sequentially into quarter 3 from our quarter 2 levels.

And lastly, as we look beyond the crisis, we do remain excited about where we position TE strategically. I'm convinced we'll get through the crisis, and there is no change to our margin expansion plans and the expectations we've shared with you. We expect to improve our earnings power by continuing to execute footprint consolidation plans, while accelerating additional cost reductions in light of the weaker-demand environment. When markets do stabilize and return to growth, we're well positioned to benefit from a recovery in China, which is about 20% of our business as well as a broader recovery in the automotive and transportation markets.

And the other thing that's great with our cash flow is that we will continue to invest in content growth opportunities to enable outperformance versus underlying end markets, and we will continue to benefit from the secular trends across the businesses and where we position TE. So if you could, I'd appreciate if you could turn to Slide 4 and in 4 -- and I'll get in to review a few additional highlights from the second quarter.

Sales of $3.2 billion were in line with our guidance, and it was down 6% on a reported basis and 5% organically year-over-year. Our orders grew sequentially, and we saw a book-to-bill of 1.05. And these orders reflect that our customers are securing supply chain of components in an uncertain supply-and-demand environment. In fact, our orders in the quarter were higher than we expected when we started the quarter. But I think a key point is that late in the quarter, we did see a falloff in orders in certain businesses, which continued into April. And I'll discuss that more when I talk to the next slide.

From an earnings perspective, our adjusted operating margins were above 16%, and adjusted earnings per share of $1.29 exceeded the high end of our guidance, driven by the strong execution of our teams in all segments. And reinforcing my earlier comments on our cash-generative business model, year-to-date free cash flow was up 34% versus the prior year. And in the second quarter, free cash flow was approximately $310 million, with approximately $430 million being returned to shareholders during the quarter.

Going forward, we remain committed to our dividend, but we'll continue to evaluate our share buyback plans in light of the uncertain market conditions. As we look forward, we are withdrawing our guidance for the full year, but we are providing a high-level view of quarter 3 as compared to quarter 2.

For the third quarter, we believe that our sales could be down approximately 25% sequentially with a roughly 45% sequential fall through to adjusted operating income on the sequential revenue decline. This reflects the order trends we're seeing with market weakness driven primarily in the Transportation and commercial aerospace markets, along with some inventory and supply chain corrections that I will discuss.

While we can't influence the market environment or how COVID will impact our customers, we remain committed to execute on the levers we can control to drive our cost reduction and footprint consolidation plans, while continuing to invest in the long-term growth and content opportunities of TE.

So please turn to Slide 5 and let me get to the order trends, not only in the quarter but also what we've seen since quarter end. For the second quarter, orders were at $3.4 billion and stronger-than-expected as customers secured supply of components in an uncertain supply chain environment, particularly in China. While we were impacted by the COVID-related shutdowns in China early in February, I am pleased with how quickly we brought our 18 factories back online. Due to the high levels of automation, our revenue was minimally impacted in the quarter, and we were able to maintain production to meet our customer commitments even with periods of labor shortages. I believe this demonstrates that our core manufacturing capability is a source of differentiation both for TE as well as our customers

As you can see on the chart, we've laid out the sequential orders for quarter 1 and quarter 2. So I'm not going to spend as much time on the actual numbers in quarter 2 but I want to spend time on what we're seeing in late March through April to provide a more accurate picture of demand going forward as the Americas and Europe were being impacted by COVID. In Transportation, we saw a drop-off of orders that started both in auto and commercial Transportation late in March and continued into April.

As you know, our customers have closed factories starting late March in Europe and North America. I am also sure, you've seen some of the announcements discussing the plant closures as well as the assumptions when production can return. In Industrial, we saw erosion of orders in commercial aerospace, but we had ongoing strength of orders in our defense business, our medical business and our energy business and our energy business services, the power utilities of the world.

In Communications, we have seen stronger demand in data and devices for cloud-based applications as data centers build out further capacity to handle the increase in high-speed data traffic and storage as well as China recovering.

And in China, which represents about 20% of our sales, in March and into April, our orders have basically returned to pre-Lunar New Year levels before the COVID outbreak occurred in China. So we are seeing a recovery in China across many of our businesses.

So let me turn to Slide 6, and I can frame how these trends connect to our sales view at quarter 3, and this is a new chart that we included for you. We are highlighting some of the major sequential drivers from quarter 2 to quarter 3 in our assumptions on this slide, but I do want to highlight, we aren't capturing all the puts-and-takes of our different businesses in the quarter. Directionally, we are expecting sales to decline approximately 25% sequentially into quarter 3. And we put these into 4 buckets.

The first bucket is around auto production. We do expect auto production globally to decline by approximately 1/3 sequentially from the 18 million vehicles globally produced in the second quarter to approximately 12 million vehicles being produced in the third quarter, which is in line with IHS' view. This production decline in auto will drive about half of our sequential decline of total company revenue.

The second bucket is an expected reduction in commercial aerospace market of approximately 1/3 due to lower production by the large airframe manufacturers. So these first 2 buckets are really market related.

The third bucket is around the auto supply chain. And with our second quarter auto sales well ahead of production, and I'll talk about that, there was a component inventory build by our customers in the quarter. As a result, we expect approximately $200 million of inventory adjustments by our customers in the third quarter, and this should be a temporary effect as that inventory bleeds off.

And then the fourth bucket covers supply chain impacts outside of auto. TE and our customers have a number of factories that are temporarily shut down due to COVID-19 as a result of government actions. We expect the resulting supply chain disruptions to impact a number of our other businesses, and this will cause a reduction of approximately $100 million in the quarter as we go through this quarter. I want to highlight, this is the near-term impact that we're seeing due to the pandemic. But longer term, we expect to continue to benefit from broad secular trends across our businesses based upon the leading market positions that we've built.

So let me now turn briefly to discuss segment results in the quarter, and we provided you with the full details on Slides 7 through 9 for your reference. I'm just going to touch it high level verbally.

In our Transportation segment, sales were down 5% organically year-over-year with declines in each of our business. Auto sales were down 2% organically, with global production declines being down 20%. Our relatively stronger performance was driven by our customer supply chain builds ahead of factory closures as well as the continued benefit of content growth. While we are in a volatile demand environment, we continue to expect increased production of hybrid and electric vehicles and ongoing adoption of autonomous features, which will continue our market outperformance that we've had for quite some time now. In sensors, I want to highlight that we recently completed the acquisition of First Sensor, which will now be included in our financial results beginning in the third quarter.

In the Industrial segment, our sales declined 3% organically year-over-year as we expected. We saw declines in commercial aerospace and industrial equipment as a result of the market weakness. However, we are seeing stability in defense, medical and energy due to positive underlying trends and expect those businesses to continue to be stable as we move through the rest of the year.

In Communications, sales and margins came in as we expected. And while data and devices declined in the second quarter, we are seeing growth in high-speed and cloud applications and expect this to continue into our third quarter.

So with that as a backdrop, let me turn it over to Heath, who will get into more details on the financials, and then I'll come back and cover our expectations for the third quarter.

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Heath A. Mitts, TE Connectivity Ltd. - Executive VP & CFO [4]

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Thanks, Terrence, and good morning, everyone. Please turn to Slide 10, where I will provide more details on the Q2 financials.

Adjusted operating income was $519 million with an adjusted operating margin of 16.2%. Adjusted EPS was $1.29, exceeding the high end of guidance. GAAP operating loss was $415 million due to a onetime noncash charge in the quarter of $900 million. This reflects a partial impairment of the goodwill associated with our sensors business. Also included are $22 million of restructuring and other charges and $12 million of acquisition charges.

We continue to expect restructuring charges in the range of $200 million to $250 million for this fiscal year. GAAP EPS was a loss of $1.35 for the quarter and included noncash charge of $2.67 related to the goodwill impairment and restructuring, acquisitions and other charges of $0.08.

On the other side, we also had a tax-related benefit of $0.12 related to the pre-separation tax matters and the termination of the tax sharing agreement shared previously. The adjusted effective tax rate in Q2 was 16.1%. And for the third quarter, we would expect a similar rate.

And if you turn to Slide 11. Sales of $3.2 billion were down 2 -- were down over $200 million year-over-year, including an impact of $60 million from currency exchange rates. But we were able to maintain adjusted operating margins over 16% in the quarter, as I mentioned. As Terrence mentioned earlier, we already had a number of actions underway ahead of this downturn, which helped us maintain healthy operating margins.

For the past 2 years, we have been executing our margin expansion plans in the Industrial segment. And about a year ago, we kicked off our factory footprint consolidation efforts in Transportation. We continue to execute on these plans and are accelerating certain cost actions due to the recent drop in volumes.

I now want to give you an update from an operational perspective. We are operating all of our factories in China and most of our factories throughout Asia. Most of our factories in Europe are operating with the -- including the recent reopening of our factories in Italy and Spain. In North America, all of our factories are open in the U.S., but we do have some plants shutdown in Mexico, including those serving automotive. Many of our customers are going through temporary shutdowns of their manufacturing operations in different regions, and all of this volatility has caused -- has resulted in supply chain dynamics that Terrence discussed previously.

In the quarter, cash from operation -- from continuing operations was $481 million, whereas free cash flow was $311 million, and we returned $433 million to shareholders through dividends and share repurchases in the quarter.

If you'll turn to Slide 12 to review our cash flow and liquidity, and this is a newer slide that we thought pertinent for this call today. We have a history of strong free cash flow generation. And for the current year, our free cash flow is up 34% year-to-date versus the prior year.

For our fiscal year, we expect free cash flow to be well above $1 billion. Our long-term capital strategy is to return 2/3 of our free cash flow to shareholders through dividends and share buybacks. And we remain committed to paying our dividend, and we'll continue to thoughtfully evaluate share repurchases in light of evolving market conditions.

We are also reducing our plans for capital expenditures to approximately $575 million this year, which is a reduction of about $100 million from our prior view 90 days ago. However, and this is important, we remain committed to funding growth initiatives that will enable future growth opportunities as that's the lifeblood of our company.

We continue to execute on footprint consolidation plans and pursue additional opportunities to drive cost reductions. Across our businesses, we have units that are being impacted to different degrees, and for those units that are most impacted, we are implementing selective furlough employees that are largely tied to where our corresponding customers have temporary factory closures. We will continue to evaluate our cost structure as the demand environment evolves. We are in a strong liquidity position with $2.3 billion available as the attached chart details our debt maturity ladder is gradual. In early February of this year, we raised EUR 550 million debt at 0% coupon. The use of the proceeds was for the acquisition of First Sensor and pre-funding of our pending $350 million debt maturity in June.

At quarter end, we had a cash balance of approximately $800 million. Given our strong cash position, we have not needed to be in the commercial paper market for some time. We have a $1.5 billion undrawn revolver committed by a strong bank group. Within the revolver covenant, we expect to be well below the 3.75 rolling 4-quarter debt-to-EBITDA ratio going forward. As a reference point, with our current debt-to-EBITDA ratio of 1.5, we are well below that threshold.

With that, I'll turn it over to Terrence to provide some additional commentaries about the forward look.

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Terrence R. Curtin, TE Connectivity Ltd. - CEO & Director [5]

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Thanks, Heath. And we have provided some details of our expectations going forward on Slide 13. So let me summarize with a few comments around the words on that page.

For quarter 3, from a market and demand perspective, we're expecting weakness to be driven by Transportation and commercial aerospace, as I've said. In addition, we are expecting supply chain adjustments in auto as well as broader supply chain impacts in other areas. And we expect the supply chain impact, both in auto and other areas to be temporary.

As a result, our best estimate for the quarter is an approximately 25% sequential sales decline with an approximate 45% flow-through to adjusted operating income on that revenue decline. And this fall-through is greater than our typical fall-through due to the shortness and severity of the volume drop sequentially. During the call, we talked a lot about Transportation and com air, but I do think it's important that we highlight the areas that are continuing to stay stable as well as we benefit from, and they are defense, medical, energy as well as data and devices. And that's about 1/3 of our revenue.

The other thing is we are in an excellent position to benefit as auto demand returns as well as China continues to recover. And while fourth quarter visibility is limited, many believe that our quarter 3, the June quarter, will be the low point in global auto production. We expect that production will improve as we move past quarter 3 and will benefit both from the production increases as well as inventory normalizing in the auto supply chain, like I've talked about. While the demand environment is uncertain, I am pleased with our operations resiliency that we've shown and our ability to continue to serve our customers during this challenging time. We have an excellent free cash flow generation model with ample liquidity. And this allows us to continue to invest in content growth and other secular opportunities across our businesses to emerge stronger when our markets return back to growth.

And with that, Sujal, let's open it up for questions.

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Sujal Shah, TE Connectivity Ltd. - VP of IR [6]

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Okay. Marcelo, could you please give the instructions for the Q&A session.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Your first question comes from the line of Shawn Harrison from Loop Capital.

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Shawn Matthew Harrison, Loop Capital Markets LLC, Research Division - MD [2]

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Terrence, I wanted to just go to that last comment of auto production into the second half of the calendar year. And just, maybe, an idea of how much it could bounce back just upon the normalization of production schedules into the September quarter? I know IHS has a pretty robust figure out there. Maybe that's not realistic, but bounce-off is 12 million. And then secondarily, do you get the same type of margin uplift as production recovers versus the downtick you're seeing in the margin profile this quarter?

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Terrence R. Curtin, TE Connectivity Ltd. - CEO & Director [3]

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Sure. Thanks, Shawn, for the question. And when you think about automotive, let me just take a step back first. And where do we think auto production was going to be before COVID started and even last quarter, and I know we talked about the $200 million supply chain impact. We thought the world was getting stable before COVID, and there was going to be about 21 million units made per quarter on the planet. And last quarter, it was 18 million. And moving from that 21 million to that 18 million, a big chunk of that was China. China got impacted by COVID and a little bit elsewhere in the world. As we move to this 12 million, from the 18 million to the 12 million, we are seeing China production tick up, but we're also seeing in the western parts of the world, the impacts of the factory closures in Europe, in North America. And that's probably going to be down collectively in the western world, about 50% so 5-0. And as we look forward, our customers are going to continue to ramp. So when you think about the 12 million unit impact, I think it is reasonable to assume you're going to get an improvement into the fourth quarter as auto factories ramp back up, and then in addition, we'll get the benefit as the supply chain works out.

So I think there's a couple of factors that point to this quarter being a low point and quarter 3 has production come back online, we get further recovery in China as well as we move back up. Where it'll be in the fourth quarter, there's lots of numbers out there. You mentioned IHS, but we do think quarter 3 would be the low point.

The other thing on your fall-down question, we would expect as we start to get whatever that level of production increase is, we do expect we'll get fall-up at a pretty significant rate. So it's the levers that Heath talked about that we've been doing on the cost side coming into this, which we're proud that we had those going. That'll give us some levers to work on during this, but I do think you can expect a pretty healthy fall-up, no different than the fall-down. And it doesn't change how we think about what we're entitled to from margin in the markets. And in a place like auto, where we are -- have a leading position. We think crises like this, we've only gotten stronger out of, and we're going to get stronger out of this one as our customers look for the partners that are going to there for. And they're going to see TE's there for them everywhere in the world.

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Operator [4]

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Your next question comes from the line of Amit Daryanani from Evercore.

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Amit Jawaharlaz Daryanani, Evercore ISI Institutional Equities, Research Division - Senior MD & Fundamental Research Analyst [5]

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Terrence, I'm curious in a post-COVID world, do you see market share dynamics accelerate in favor of larger companies. And do you think trends like integrated solutions for connectors and sensors becoming more attractive to folks? I guess I'm just trying to understand when you've gone through recessions in the past, have you seen TE benefit from share gains as you go through a recovery?

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Terrence R. Curtin, TE Connectivity Ltd. - CEO & Director [6]

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It's a great question, and thanks for it. I think what you see, as companies go through, we have benefited through these crises to gain share. And I think back to '08 and '09 a little bit, while the company is very different, we did gain share because of the financial stability we have that Heath talked about. And also our global customers really looking to how do we get deeper, and who's going to support them. And I actually believe that what you saw in our operational performance in the second quarter, we did benefit, where other people couldn't deliver, we could. And as people were trying to secure supply chain, they were looking for who could keep their supply chains going in an uncertain time. So I do believe it's a differentiation point.

I do think, as we've always told you, share doesn't move in big chunks in our industry. But they're going to be looking for the partners as they look forward. And I think between how our engineering teams were able to shift over to online innovation, we didn't see a tail-off in projects and also how we've been adapting our supply chain and also not only ours, also helping our supply chain partners that are below us understand the safety protocols we expect because they are an extension of us. I'm pretty proud of what we accomplished. And I do think it creates opportunity for more stickiness as we come back. And I do think it's shared opportunity, and that's one of the things we view positively about this crisis.

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Operator [7]

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Your next question comes from the line of Deepa Raghavan from Wells Fargo.

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Deepa Bhargavi Narasimhapuram Raghavan, Wells Fargo Securities, LLC, Research Division - Associate Analyst [8]

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The backdrop is what it is, not much to control there. So I'm going to ask a little bit of forward-looking question just like the prior 2. You touched upon this a little bit, Terrence, but could you point to some specific signs of recovery we should be monitoring for here in Europe and North America, especially automotive vertical. I mean, granted, we understand it won't be the same playbook as China or even the trajectory as China in terms of trend. That's one part. Secondarily, as you look at your overall portfolio, what are some of the verticals that we think -- that we should be looking for to believe that some segments that recover early and some that probably recover with a lag?

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Terrence R. Curtin, TE Connectivity Ltd. - CEO & Director [9]

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Sure. Thanks, Deepa. And I'm probably going to spend more time on the second part of your question because I do think it's important. And I also think we spend a lot of time on the script framing, we're seeing in auto and com air. But when you think about our portfolio, there is 1/3 of our portfolio that is feeling very little impact or minor impacts. And our data and device cloud business actually, we continue to see an acceleration in those orders. Our medical business has been very stable. Our energy business has been stable. And as we've been talking to you, defense has stayed stable and remains at a very high level. That envelope, there's about 1/3 of TE than I would say right now is very stable from an order perspective. We may have some areas where -- in countries where governments asked us to stay shut for a little bit. But those indicators, I think, are continuing to remain stable, and I feel good about how our teams are performing there. That's about 1/3.

Then there is, I would say, our industrial equipment business as well as our appliance business. We do see some softness there. Both are benefiting from the recovery in China. Both have big China presences. But they are being impacted in the west, and I do think they'll stay soft in the west. They have different underlying drivers. And in the Industrial business, that would probably come back more as how does CapEx play out over time is what you would look at there.

The third business is clearly Transportation. I think it does come into auto builds. And I think we spend a lot of time on that. But what I would also always highlight to you, remember, our unique position versus many companies. We're global. We are stronger in Asia and Europe and North America. So I do ask you, as you look at builds, and I know this group does, the Asian and European builds are very important with North America sort of being a lower impact. And I know sometimes as being in the United States, we look at the U.S. builds more than the global builds. But I think as Asia comes back and Europe comes back, they are stronger positions and very important to us.

And then the last market I haven't talked about that I would say, I don't think I'm going to surprise anybody, is the com air space. The com air space, which is around $550 million of annual revenue for TE, and I know in the comments, I said we expect it to be off 1/3 and sort of a waterfall from Q2 to Q3, we do think that's a market that's not going to be coming back near term. I think there's many other. You can look at what Boeing has said, what Airbus is saying and elsewhere, that's one that's going to be down for a while. So I think -- I hope that answers the gamut of what you can look at in some of the indicators. And I also think it relates to some of the underlying. And I appreciate the question.

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Operator [10]

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Your next question comes from the line of Christopher Glynn from Oppenheimer.

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Christopher D. Glynn, Oppenheimer & Co. Inc., Research Division - MD and Senior Analyst [11]

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Was curious to hear you talked about, Terrence, the U.S. factories and facilities up and running, Mexico, still pockets of shutdowns. Are there any key differences between government mandates and how those roll through in the respective production regions? And also, any major impacts of just how people, workers are responding independent of government mandates.

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Terrence R. Curtin, TE Connectivity Ltd. - CEO & Director [12]

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Thanks for the question. And I know Heath went through in the prepared comments of where have we seen things. What we have seen is government responses are very different. And I would say the vast majority of the world, because of where our products go, we have been deemed essential, and we have been able to run to make sure that our products continue to go out in all the applications they support. There are countries that have taken broader shutdown. Heath mentioned in Europe, we had some in Italy and Spain that were more severe than elsewhere. We had to take those down. Those factories are coming back up. And then also, Mexico has been one that has gone a little bit narrower on what they deem as essential. It's been much more around medical as well as food processing. And they've been sort of individually bringing other industries on, and we're sort of following that lead. So we are partially running in Mexico. And so the government answers around the world have been very different. So that's one element.

On the people side, certainly, we need to do the things that keep our employees safe. And being a global company, as China went through COVID, we learned a lot of practices that were able to get us up in China quickly, what kind of regulation to put in, and we've been rolling those around the world. And it's one of the things that I think our supply chain team has done a tremendous job as well as our crisis team to really make sure whether it's protective equipment, temperature screening, and you can keep going, how do we change some of the layouts of our factories to make sure you don't have concentrations of people. And there are things -- you have some retraining of employees to make sure that they're comfortable at the environment they're coming back into. And it's also -- we continue to invest in automation. And that's something I do believe the investments we've made over the past handful of years around automation have also allowed us to be less labor-intensive in certain parts of the world than we were 5, 10 years ago. So like everybody, it's very complex. We're working through it. And certainly, for those areas that are ramping back up, we have full procedures around how we get our employees back to work, how do we prioritize our employees to come back to work to really make sure we keep them safe.

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Operator [13]

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Your next question comes from the line of Wamsi Mohan from Bank of America.

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Wamsi Mohan, BofA Merrill Lynch, Research Division - Director [14]

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Terrence, can you compare how TE is different this downturn versus the last downturn? It feels like your breakevens are quite different. Trough margins appear a lot higher than they did last time around. And if I could, what would decremental margins have looked like in your fiscal 3Q without the supply chain adjustments?

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Terrence R. Curtin, TE Connectivity Ltd. - CEO & Director [15]

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All right, Wamsi, I guess I have to take this question because Heath wasn't here in '08 and '09. So I guess it's pointed at me. As we talked to a lot of you about, and I know some companies have gone out and said, as they're thinking about the guide, they compare it to '08 and '09 as to how they're modeling their playbook. I think there's some things that are similar, TE today versus '08 and '09. But I would tell you, there's a lot of things that are a lot different. With all the moves we made in the portfolio, where we positioned TE, the cost actions we've taken. So let me try to summarize what's the same a little bit. But also the things that I think we've improved the business and the portfolio. The one thing that I would say is probably the #1 thing that is the same, it's the cash generation model we have. Our cash generation will be very resilient during these times. And as you all know, we use working capital in times of growth. And one of the things that when you do get a little bit of a cycle, like this and you have some of these, we're going to generate free cash flow, we're going to adjust CapEx around capacity, we're going to invest in growth CapEx. And I think that's one of the things that's always allowed us back to the question earlier to get stronger during crises because we can continue to invest around growth, but also keep our strong cash generation model going. That's the big thing that I think is the same.

Now when you think about things that are different, our portfolio is a lot more focused and a lot stronger than it was in '08 and '09. And the businesses we are in, all have secular trends that we position TE around. And we've gotten rid of the businesses that don't have those trends. And if you look here today in '08, and '09, we had no growth telecom businesses, you had a lot more consumer electronics, and we built a platform like medical. So I do think the portfolio is more focused and stronger. The other thing that I would say that is also very different is our automotive business. While we did have a sizable automotive business back then, and we have a sizable business today, it's a very different business. While it was always global, China makes up 25% of the car production on the planet, in '08 and '09 , it didn't. And our leading position is special.

I would also tell you, our automotive business, going into the last crisis was company average business from a margin perspective. Our margin in our Transportation segment going into this crisis is a lot higher than it was, and a lot of the cost actions we initiated out of the last crisis that we continue to work on, and Heath talked about, that we were teeing up. And overall, the company's in better financial shape. Our margin is 300 basis points higher today than it was in '08 and '09, just going into a crisis. And our balance sheet is in a very -- much more healthy place. So when I sit there, what if auto production changes, we will be impacted? When I think about the health of TE and things like that, what we've done to the cost position and strengthened our position in markets we wanted to be in as well as not being in markets we didn't want to be in, I think it's positioned us well to be a strong company going into a crisis that will get stronger coming out of.

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Operator [16]

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Your next question comes from Mark Delaney from Goldman Sachs.

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Mark Trevor Delaney, Goldman Sachs Group Inc., Research Division - Equity Analyst [17]

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I was hoping to better understand how TE is thinking about its content per car opportunity. I realize you already described some near-term inventory adjustments in the auto market for the completed quarter and for the current quarter. But if you put that aside, is there any change to how you're thinking about your content per car opportunity, either because of pricing dynamics or delays in new car launches?

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Terrence R. Curtin, TE Connectivity Ltd. - CEO & Director [18]

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Thanks, Mark, and I'll take that. And what's interesting is we don't. As I said earlier, the emission requirements in places like Europe are not changing. We also believe even with this change in production, the number of global hybrid and electric vehicles will still be up year-over-year, even in a lower production environment, and all the production growth that's been taken out are combustion engines. So the 4% to 6% that we've always talked to you about, when we look through where our growth is coming from, our engineering projects as well as the trends, certainly, electric vehicles are continuing to accelerate. We've talked to you before, autonomy, it's probably a little bit further out. But net-net, the 4% to 6% content opportunity continues to be real, and it hasn't changed, the way we think about it.

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Operator [19]

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Your next question comes from the line of Joseph Giordano from Cowen.

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Francisco Javier Amador, Cowen and Company, LLC, Research Division - Associate [20]

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This is Francisco on for Joe. Can you guys expand on the $900 million impairment charge that you guys took this quarter, please?

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Heath A. Mitts, TE Connectivity Ltd. - Executive VP & CFO [21]

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Sure. This is Heath. This is related to our sensors platform, most of which was acquired in 2014 with the acquisition of Measurement Specialties. So there's been subsequent acquisitions that have come into that platform, over the years, of smaller size. And -- but there's been a downturn in those markets here for a while. And particularly in the Industrial space, which is about half of our sensors business, we've seen a downtick here going back several quarters as well as following the trends that we've seen in other industrial businesses as well as in the commercial transportation space, which is about 1/4 of the sensors business. So that factored in with a down -- an outlook that is consistently down with everything else we've talked about today, did push us to take a harder look at where we sat relative to the accounting treatment of that, and we've made an election in the quarter to take that charge based on the accounting rules that govern that. It's a noncash charge, and it kind of rightsizes the carrying value from accounting perspective.

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Operator [22]

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Your next question comes from the line of Craig Hettenbach from Stanley -- Morgan Stanley.

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Craig Matthew Hettenbach, Morgan Stanley, Research Division - VP [23]

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I just wanted to follow-up on understanding there's a lot of pressure on auto production, but just going back to the content theme, particularly from a sensor pipeline perspective, just curious, prior to these disruptions, how you were feeling about kind of design win activity for sensors and any update on just the work you're doing in combination of sensors and connectors?

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Terrence R. Curtin, TE Connectivity Ltd. - CEO & Director [24]

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Yes, sure, Craig. Thanks for the question. And when we think about it, the revenue pipeline we have around sensors and automotive continues to stay robust. Certainly, it's going to be impacted by lower production builds on the planet. So -- and that ties into a little bit what Heath talked about in the prior question. But that momentum, as you continue to see how sensors need to play in a car, actually around whether it goes to electric and current sensing, what happens on autonomy as well as the momentum of our TERP, our revenue pipeline, that momentum still stays strong, similar to the engineering projects, as I said. So nothing has changed there. Certainly, it's being impacted by the end market downturns in auto and Industrial Transportation, like Heath said. But when we think about the opportunity about that content, that opportunity has not changed per vehicle. It's really the number of vehicles made that has been impacted.

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Operator [25]

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Your next question comes from the line of Samik Chatterjee from JP Morgan.

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Bharat Daryani, JP Morgan Chase & Co, Research Division - Analyst [26]

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This is actually Bharat on for Samik. So continuing on the automotive market, I just had one question. So what are you seeing in terms of order trends or erosion, specifically in the China automotive market. I mean, the latest IHS data, we saw yesterday is showing some stability, although at a low level in the automotive production outlook for China. So are you starting to see the same stabilization in order trends as well?

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Terrence R. Curtin, TE Connectivity Ltd. - CEO & Director [27]

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Yes. Well, a couple of things that when it comes to China. China, we have seen production increase and production will increase off of the low quarter 2 levels that you have in China. And we do expect production as our customers have ramped up. So that is in, I'll call it, a healing process. The other thing that I think was a nice data point to have is that in March, there was about 1.3 million cars sold in China. Certainly, the consumer element needs to come back. But that alone, if it stayed at that March rate, would be about 16 million to 17 million unit SAAR based upon the March sales. So all those factors need to continue to improve, but we do see increased production and the production decline from quarter 2 to quarter 3 is really in Europe and North America that we've highlighted.

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Operator [28]

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Your next question comes from the line of David Leiker from Baird.

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David Jon Leiker, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [29]

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So I'm looking at the slide on Transportation Solutions where you say your sales were down 2% organically with build down 20%. And normally, that gap would be a function of content gains or mix shifts, but it sounds like supply chain is a piece of that and maybe a large piece of it. I might have missed that, but -- but if there's a way that you can quantify how much of that variance between the build rates and your revenues came from supply chain that might end up reversing on you here later in the year?

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Terrence R. Curtin, TE Connectivity Ltd. - CEO & Director [30]

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David, it's Terrence. When we talked about quarter 2 to quarter 3 being down sequentially, there was an element of auto production going from 18 million to 12 million. We also estimate back to those data points that you've said, there was about $200 million, where our customers were putting orders on us, we delivered with what we were able, to continue to get our factories up. That $200 million is what will turn here in the third quarter. And that's one of the numbers we highlighted in quarter 2 to quarter 3. And the simple way to think about it, our auto revenue in the quarter was pretty much as we expected. We thought there was going to be 21 million cars made in the plant. There was 18 million. It's 3 million vehicles times $65 gets you to about the $200 million that we're estimating that was, hey, revenue that you could sort of say, probably should have been in quarter 3. We were able to ship it in quarter 2 as people were really trying to deal real time with COVID-19. And that will work through and normalize as we go through quarter 3.

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Operator [31]

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Our next question comes from the line of David Kelley from Jefferies.

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David Lee Kelley, Jefferies LLC, Research Division - Equity Analyst [32]

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Just a quick question -- just a quick one on distribution channel exposure. I think you referenced in the slide deck ongoing industrial corrections. Just wondering if you could give us some color into what you're seeing in data and devices and appliances as well. And maybe more broadly, how do you see channel health shaping up into the back half of the fiscal year here?

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Terrence R. Curtin, TE Connectivity Ltd. - CEO & Director [33]

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Thanks for the question. And certainly, we've been talking a lot about end markets, and we do typically talk about channel. Over the past 6, 9 months, we've been in an element of where our channel partners have been correcting. And what I would say we've seen is that correction of their inventory position seems to have normalized. As we've ended March, probably across our markets, with the exception of being our industrial business and total TE channel is up to about 20%. So what we've seen from POS trends, which is what our distributor is selling out, outside of Transportation and com air type of markets have been pretty steady. So we're watching those indicators to see if there's inventory builds. It feels okay right now, but there is the Industrial market that feels like it has a little bit too much inventory in it. And certainly, with the demand impact, and we're going to have to keep an eye on it. But right now, it feels stable outside of Transportation and com air.

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Operator [34]

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Your next question comes from the line of Jim Suva from Citigroup.

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Jim Suva, Citigroup Inc, Research Division - MD & Research Analyst [35]

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When we hear about the commercial aerospace, and also, to some extent, the Transportation industry of autos and trucking, we also hear about the OEMs talking about price concessions to suppliers and having to do things or change things. Can you -- while a lot of the commentary prepared was on about the unit production, can you talk about expectations for price concessions? Or is that other parts of the supply chain that you see happening? And any thoughts around that?

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Terrence R. Curtin, TE Connectivity Ltd. - CEO & Director [36]

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Sure, Jim. Thanks for the question. So when you look at it, our pricing environment has been relatively stable. And when I say stable, we do give in, automotive and places like that, productivity back to our customers and their annual negotiations, their annual negotiations around the investments we make as well as the volumes they hit. So those discussions will be coming up. What I would anticipate similar to other crises, our price erosion will stay pretty much at the historical rates it's been at based upon the value we provide. So I don't see us having an acceleration of price erosion. It is a key element of when we talk earlier about where we believe entitled margins for this business can be price supportive. And I don't see an acceleration that's going to happen in price erosion because there's also certainty of supply that's also needed at the same time. And I think our position we have both from an innovation and the manufacturing with our customers create a proper balance that we'll be able to keep it where it's been.

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Operator [37]

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Your next question comes from the line of Matt Sheerin from Stifel.

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Matthew John Sheerin, Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Senior Equity Research Analyst [38]

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So a question just regarding some cost cutting actions. Heath you talked about, it sounded like just ongoing cost-cutting actions that you've been doing and then some furloughs, but nothing incremental in terms of taking any fixed costs out. So what are your thoughts there? And at what point do you take that next step to do some further consolidation, particularly if we're in a longer recession and the auto market doesn't recover as quickly as maybe you think.

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Heath A. Mitts, TE Connectivity Ltd. - Executive VP & CFO [39]

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Matt, I appreciate the question and the follow-up. So let me just try to clarify a few things. As we discussed, and you mentioned earlier in your question, for the past couple of years, we've been talking pretty transparently about what we're doing in the industrial space. And then about a year ago, talked about several -- initiating several auto -- generally auto-related factory footprint consolidation. So we weren't caught flat-footed with this. Now the severity and the sharpness of a sequential downturn of 25% will certainly -- is something that is challenging to deal with from a margin perspective in a 90-day window. However, our focus continues to be on permanent cost reductions. Obviously, we'll do things like furloughs, where our customers have furloughed, and we don't want people staying around our factories. But when we think about cost reductions and incremental cost reductions, they tend to be in the form of permanent so that our exit trajectory will move back into periods of growth, will be stronger than when we entered it. That's a combination of both accelerating some of the things that we already had in place, which this reduction in demand does allow us to accelerate some, just given that we have the ability to ramp up inventory builds and some of the other things that are important to any kind of transfer. But we are also evaluating and moving pretty quickly through additional restructuring actions.

So if my comments were light on that, I apologize. We will be doing some things. Now on the factory side, those are underway, and I don't think there's something we have to start with a clean piece of paper on. But the business will be rightsized, but we're focused on what we look like and a more permanent perspective as we leave in that move that it makes in terms of our overall margins as we get back to levels of more normalcy on that particular front. And you also have to remember, if you just step away from auto for a second, we have chunks of the business that are actually fairly stable or at full production. Terrence mentioned defense, data and devices, certainly our medical and our energy businesses, those are businesses that -- we're in full production just to keep up with our customers right now. So it's a little bit different flavor depending upon which chunks of our business that we look at. But auto specifically, we'll make sure we're sized right for not just what we think the next couple of quarters are going to look like, but what it looks like for -- in our FY '21 and FY '22. And I think that's important to keep that in perspective.

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Operator [40]

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Your next question comes from the line of William Stein from SunTrust.

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William Stein, SunTrust Robinson Humphrey, Inc., Research Division - MD [41]

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Heath, a moment ago, you talked about performance of sensors in the industrial end market. And incidentally, I think there was some progress on the First Sensor acquisition late in the quarter. Can you update us on the status of the integration of that company and its product portfolio and in your future plans in that category?

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Heath A. Mitts, TE Connectivity Ltd. - Executive VP & CFO [42]

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Sure. And Will, thanks for the question. Listen, sensors continues to be a very important part of our -- that platform is an important part of our growth strategy. And we still feel very good about -- despite the accounting treatment that we undertook in the quarter, we still feel very good about the long-term prospects of where we are. Terrence commented on a question earlier related to the auto component of that revenue pipeline for sensors, which continues to be very strong. Now some of those things based on volume and so forth, have pushed to the right a little bit. But our design-in wins continue to be very strong within auto sensors. We are very well positioned within the commercial transportation sensors as well. Now that's a business that we started feeling the pressure both on the sensor side as well as our connector -- traditional connector side of the business, going back in the late summer time frame of last year, and certainly, that has continued to be pressured. But we are very well positioned from a market share perspective there. So between auto and commercial transportation, that makes up about half of our sensors business.

And then you get into the industrial piece of it. Industrial piece of it does touch a lot of different end markets, some of which are more attractive than others, but no different than our industrial business within our industrial segment that we noted, it was down double digits organically. We are feeling similar pressures within that component of our sensors business. So as you see us move forward, you're going to see us talk about it, First Sensor fills in a nice product gap for us. We are in a very good position in terms of that. That's been a long process to get executed on. We currently own just under 3/4 of the shares. And as Terrence mentioned earlier, we'll begin to incorporate some of those financials in our results in this third quarter moving forward. And then there's additional processes that we follow within the German law and regulations to continue to bring the rest of those shares online. And -- but we feel very good about the progress on that. It's just been -- it's been a long process. And -- but the product set and the manufacturing operations and what it brings to us is still very important. And so you'll continue to hear us talk about sensors as part of our growth.

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Operator [43]

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Your next question comes from the line of Joseph Spak from RBC Capital.

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Joseph Robert Spak, RBC Capital Markets, Research Division - Analyst [44]

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I just quickly wanted to go back to your estimate of the auto supply chain impact because if you back out that $200 million, you were sort of really more in line with global production in your second quarter. And I know you have a longer-term outgrowth opportunity, but was there something specific to either mix or share that impacted this quarter?

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Terrence R. Curtin, TE Connectivity Ltd. - CEO & Director [45]

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No. On any one quarter, you're never going to have a perfect 4% to 6% because of all the supply chain elements that happen. So there wasn't anything specific. And the supply chain impact, let's face it, it is an estimate on our behalf with all the moving parts we have. But the content that we see happening, the 4% to 6%, there's no change in that. And you should look at that over a year period or so, not 1 quarter.

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Operator [46]

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Your next question comes from the line of Nik Todorov from Longbow.

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Nikolay Todorov, Longbow Research LLC - Analyst [47]

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I understand a big portion of your out inventory adjustments will occur in the June quarter. But I guess, can you talk about your expectations regarding destocking potentially lasting into the second half of the year? I mean in other words, do you expect the correction to be a deep and quick one contained only in the June quarter? Or you see some spillover?

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Terrence R. Curtin, TE Connectivity Ltd. - CEO & Director [48]

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Well, what we've said is some of the destocking, in some cases, because of the -- being the automotive supply chain. The automotive supply chain is sort of -- at least how I think about it, is sort of a 6-week just-in-time supply chain. It's not an industrial supply chain or a channel supply chain that is very, very spaghetti like. So when we sit there and the way that we're guiding is we sort of assume as our customers ramp back up, they will burn off this extra stock. Certainly, that's our assumption. Could it last a little longer? Potentially, but it'll depend how they ramp. And certainly, they don't like a lot of excesses in the supply chain. So we view it would be probably over a 3-month period was reasonable.

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Operator [49]

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Our last question comes from the line of Shawn Harrison from Loop Capital.

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Shawn Matthew Harrison, Loop Capital Markets LLC, Research Division - MD [50]

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Heath, just a follow-up on both kind of the restructuring and kind of the normalized goals. To be clear, there is no change in kind of the normalized margin profile you're searching -- you're targeting for any of the 3 business lines? And then second, I think you've done $650 million -- or that you're targeting in '18, '19 and '20, about $650 million of restructuring. Where are you in terms of the payback of those restructuring actions? Are you 1/3 of the way through it right now or even less?

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Heath A. Mitts, TE Connectivity Ltd. - Executive VP & CFO [51]

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Well, Shawn, I appreciate the question. The normalized margins for the business, as we've talked about, right, which is TS, up in the high teens towards 20 number; IS, consistently in the mid- to high teens; and then CS, kind of in that low to mid-teens, consistently growing up towards that number, that has -- those are unchanged. Now we're going to need to see, in certain cases, volume come back to support some of those things. But the longer-term actions that we're taking to take out more permanent cost will certainly help close some of that gap. So as I think about the restructuring that we've done, most of it's been fairly programmatic, things that we've done that are very specific to facility moves within Industrial and then subsequently, Transportation, and that continues on for the charges that we anticipate taking in this fiscal year, FY '20. The payback on those is kind of about a 3-year payback, which is a little bit longer than your traditional payback if you were doing things in the U.S. But you got to remember, as we've discussed before, some of the plants were taken offline are in jurisdictions where the cash outflow to get those things offline is a bit longer. So the blended payback is about 3 years.

I would tell you we're at different points depending upon which facility we're talking about. For obvious reasons, they've had different start and stop dates. And there's challenges that, in some cases, are created based on this current situation with COVID, meaning that there are certain factors that, maybe on the receiving end, have certain things that have slowed, so that's harder to do. And there's other things that have sped up because we're able to go through operational matters that are specifically inventory builds that our balance sheet can certainly support and allow us to get those costs out sooner. So there's a blend in where we are. If you were just to ask me to try to frame all that up and for TE in total, I would say we're kind of halfway through that process. Sometimes a charge on the P&L can be taken a year plus before you actually see the savings come out just based on how the accounting for it works relative to when the costs are actually eliminated. So there is a bit of a lag in terms of that.

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Sujal Shah, TE Connectivity Ltd. - VP of IR [52]

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Okay. It looks like there's no further questions. If you do have questions, please contact investor Relations at TE. I want to thank everyone for joining us this morning. Thank you.

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Operator [53]

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Ladies and gentlemen, your conference will be made available for replay beginning at 10:30 a.m. Eastern Standard Time today, April 28, 2020, on the Investor Relations portion of the TE Connectivity's website. That concludes your conference for today.