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TE Connectivity Ltd. (TEL) Q3 2019 Earnings Call Transcript

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TE Connectivity Ltd. (NYSE: TEL)
Q3 2019 Earnings Call
Jul 24, 2019, 8:30 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Ladies and gentlemen, thank you for standing by, and welcome to the TE Connectivity Third Quarter Earnings Conference Call for Fiscal Year 2019. At this time, all lines are in a listen-only mode. Later, we will conduct a question-and-answer session. [Operator Instructions] As a reminder, today's call is being recorded. I would now like to turn the conference over to our host, Vice President of Investor Relations Sujal Shah. Please go ahead.

Sujal Shah -- Vice President, Investor Relations

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

During this call, we will be providing certain forward-looking information, and we ask you to review the forward-looking cautionary statements included in today's press release. In addition, we will use certain non-GAAP measures in our discussion this morning, and we ask you to review the sections of our press release and the accompanying slide presentation that address the use of these items. The press release and related tables, along with the slide presentation can be found on the Investor Relations portion of our website at te.com.

Due to the large number of participants on the Q&A portion of today's call, we're asking everyone to limit themselves to one question to make sure we can give everyone an opportunity to ask questions during the allotted time. We are willing to take follow-up questions, but ask that you rejoin the queue if you have a second question.

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

Terrence R. Curtin -- Chief Executive Officer

Thank you, Sujal. And also, I appreciate everyone joining us today as we go through our third quarter results and our revised outlook for 2019. Before I get into the slides, let me frame out a few key points that we're going to talk about in today's call. First off, I'm very pleased with our execution in the third quarter. We delivered adjusted earnings per share $0.07 above the midpoint of guidance despite sales being $60 million below the midpoint and what continues to be an uncertain market backdrop that weakened, since our call with you just 90 days ago.

Despite this weaker market backdrop, I want to stress that we continue to be focused on executing our strategy and the multiple levers in our business model. And as we've been sharing with you and started at our Investor Day there's three areas of key focus within our business model. Which include topline growth number one; secondly, margin expansion; and thirdly capital deployment. And when we think about these three areas and starting with the growth one growth is around positioning our portfolio in markets with long-term secular trends that enable organic outperformance from content growth through the cycle. As well as expansion of our portfolio inorganically.

When we think about the second lever of margin it is looking at structural cost improvement through both footprint rationalization, as well as, selling, general and administrative expense initiatives that give us scale advantage.

And on the third, when we think about capital deployment, it starts with our strong cash flow generation model and how we balance the capital return as well as, expanding our portfolio that, I think we've been pretty clear on in our experience that you've had with us has been pretty consistent. When we think about this year and you really driven by the market environment backdrop the organic growth lever is being challenged after two years where it was the key pillar of our performance. And in 2019, we have been focused on executing on the other levers to protect margin and earnings performance. As we look forward we are reducing our full year guidance for both sales and adjusted earnings per share due entirely to the incremental market weakness that we are experiencing.

During last quarter's earnings announcement. We indicated that we were seeing stabilization in key end markets and that was reflected by sequential order growth that we are experiencing. Now, since that time we have seen this trend reverse and have seen a sequential decline in orders. Order patterns when you take it into the two big buckets of this decline. The first one is a further drop in auto production in China. And then the second is broad inventory destocking of electronic components in the distribution channel.

And both of these are really why we've adjusted our outlook.The other thing that I want to stress, before I get in the slides is that the proof on the execution against our levers in our model. In this challenging market is really industry --illustrated not only by our third quarter performance where we grew earnings per share on a sales decline, but also the change in our guidance since the start of the year.

Our original fiscal year guidance last November was for sales of $14.1 billion and adjusted earnings per share of $5.70. Our current guidance is for sales of $13.4 billion and adjusted earnings per share of $5.50. Current guidance represents a $700 million drop in sales, but only a $0.20 drop in adjusted earnings per share versus our guidance at the start of the year. And what I would tell you, I think this is proof of execution versus the leverage in our model as well as the improvement we've made in this portfolio to enable margin and earnings resiliency through a cycle.

So let me now get into the slides and Heath and I'll go through them and get into more details. And let's start with Slide 3, and I'll review the highlights in the quarter. From a topline perspective sales were $3.4 billion and this was down 5% year-over-year on a reported basis and down 3% organically.

The difference between reported and organic is primarily due to a headwind of approximately $125 million, which is due to currency translation. In our Transportation segment, our sales were down 4% organically, due to a greater than expected decline in auto production that was at 10% globally and this was driven by China. Our industrial segment grew 2% organically in line with our guidance. Driven by strong performance and growth in our commercial aerospace, defense and medical markets. And our communication segment declined 11% on an organic basis, which was lower than we expected, due to inventory destocking in the distribution channel.

From an earnings perspective. Our third quarter adjusted operating margins were 17.6% up 20 basis points year-over-year, as well as up 60 basis points sequentially. This is really due to our team's execution of the cost levers, I mentioned earlier and operating margins are up both year-over-year and sequentially, despite revenue declines.

From an earnings per share perspective, our adjusted earnings per share was $1.50 and exceeded the high end of the guidance, despite the lower sales and was driven by the strong operational execution that I mentioned.

In addition to the earnings. Our strong cash generation is a key enabler of our business model. And our free cash flow was $515 million in the third quarter. Year-to-date, our free cash flow was $928 million and is up approximately 27% versus the prior year.

During the quarter we returned $307 million to shareholders through buybacks and dividends. And in addition to return of capital, our capital deployment strategy continues to include building out our portfolio inorganically to further capitalize on the secular trends to drive future growth. In the quarter, we completed bolt-on acquisitions of the Kissling Group that will benefit our commercial transportation business, as well as Alpha Technics provider of temperature sensing technology into the medical market.

In addition, we also announced our intent to acquire First Sensor, which is a German public sensor company that serves auto, industrial and medical markets and just how that process works that will, that will be further out and will close immediately.

So now let me talk more about the change in guidance. And as I mentioned earlier it's based solely upon the weaker market conditions and we're reducing the full sales outlook by $250 million to $13.4 billion, and the midpoint of adjusted earnings per share guidance by $0.10 to $5.50. Of the $250 million reduction from our prior view approximately two-thirds is in transportation, which is primarily driven by China -- China auto and approximately one-third is in communications, which is primarily driven by lower demand in the distribution channel as a result of destocking by our partners.

As a result of market conditions, we're also further increasing the scope of our restructuring to $375 million this year, which is an increase of a $125 million from our prior view and Heath will get into more details later. So, I appreciate if you could turn to Slide 4, and let me get into the order trends by our segments. In the third quarter, our organic orders were down 10% year-over-year and 4% sequentially reflecting end markets and inventory trends that I mentioned. Our book-to-bill was 0.98, and our orders declined in each region and in each segment.

By segment, transportation was down 10% organically year-over-year. Reflecting further declines in auto production primarily in China. The sequential order increases we saw in China in the second quarter reversed in the third quarter as both auto sales and production figures weakened further.

By region, we saw year-over-year declines in the double-digits in China as well as in Europe. And mid single-digit decline in the Americas.

In the Industrial segment, industrial orders were down 5% organically driven by industrial equipment partially offset by growth and aerospace and defense, as well as in energy. I do want to highlight that in our Industrial Equipment business it does have a high ratio of sales through the distribution channel.

In our Communication segment orders were down 17% organically year-over-year driven by broad based weaknesses across all regions.

So let me talk a little bit about what we're seeing in the distribution channel. And as I mentioned earlier, we are being impacted by destocking by our partners. At the total TE level this fiscal year. Approximately 20% of our sales are through our distribution partners. And we have higher levels of concentration in the Industrial and Communication segment. We've seen a large reduction in orders by our distributors, as a result of broader inventory trends that go beyond our products and it goes into other component areas.

Based on, in the order patterns, we are expecting a substantial reduction in distribution revenue in our fourth quarter, which we have reflected in our guidance.

So please turn to Slide 5, and I'll discuss our segment results in the quarter. And as always, I'll start with transportation. Transportation sales were down 4% organically year-over-year. Our auto sales were down 4% organically versus auto production declines of 10% in the quarter that I mentioned earlier. Our out performance versus auto production continues to be driven by content growth from the secular trends we positioned around including electric vehicles and increased autonomous features.

For the full year, we continue to expect content growth to partially buffer auto production declines, consistent with the content growth targets we've laid out for you. In commercial transportation, sales were down 5% organically reflecting broad market weakness, both across markets and regions. And our sensors business grew 1% organically year-on-year with growth driven by industrial applications.

From an earnings perspective for the segment adjusted operating margins were 18.6% and they grew 110 basis points sequentially. As a result of the accelerated cost actions we talked to you about. In light up market conditions, we expect to take additional cost actions, which is reflected in the increased restructuring charges I mentioned earlier. So please turn to Slide 6, and I'll discuss our Industrial Solutions segment.

The segment sales grew 2% organically year-over-year in line with our expectations with growth in aerospace, defense and medical, really being the growth drivers. Our aerospace, defense and marine business delivered a very strong quarter of 17% organic growth, driven by both new program ramps and commercial aerospace, as well as the defense side.

In industrial equipment sales were down 6% organically driven by inventory destocking, partially offset by strength in medical applications. Also our energy business was flat on an organic basis, with growth in North America, offsetting declines in Europe. From an earnings perspective, industrial solutions adjusted operating margins expanded 220 basis points over the prior year to 16.6% driven by strong operational execution by our team. I'm pleased that we can still generate strong performance in this quarter despite a challenging market environment. And our plans remain on track to expand adjusted operating margins into the high teens over time for the segment.

So let me turn to Communications Solutions and then flip the Page 7 please. Communication sales were down 11% organically, well below our expectations. And it goes back to what I talked about earlier, this segment has the highest percentage of business going through the distribution channel. So there is a greater impact from inventory destocking in this segment. Adjusted operating margins were 14.9%, they declined 70 basis points over the prior year, due to volume. So with that, I'll turn it over to Heath to cover the financials for quarter three, and I'll come back and cover guidance.

Heath Mitts -- Executive Vice President and Chief Financial Officer

Thank you, Terrence. And good morning everyone. Please turn to Slide 8, where I'll will provide more details on the Q3 financials. Adjusted operating income was $596 million with an adjusted operating margin of 17.6%. GAAP operating income was $520 million and included $67 million of restructuring and other charges and $9 million of acquisition charges. Last quarter we mentioned that we were broadening the scope of our cost initiatives to better align the cost structure of the organization with the market environment.

Given the market conditions, we are taking further advantage of the current low end demand to reduce our fixed cost and better align our footprint with our customer supply chain. Hence we are increasing our estimate of restructuring charges to $375 million for the full year. This represents an increase of a $125 million versus our prior view. The additional actions are primarily in our Transportation and Communications segments. I'm confident that the initiatives we've taken so far this year have enabled margin and EPS resiliency despite weaker markets. We are now further accelerated cost actions to ensure that we can preserve margin and EPS performance during this part of the cycle. As we have shown in the past this will enable us to realize improved margin as demand returns.

Adjusted EPS was a $1.50 up 6% year-over-year. We were able to grow adjusted EPS year-over-year despite a reduction of revenue which demonstrates our ability to execute on multiple levers to drive earnings performance. GAAP EPS was $2.24 for the quarter and included $0.91 tax benefit, primarily related to Swiss tax reform. This benefit was partially offset by restructuring, acquisitions and other charges of $0.17. The adjusted effective tax rate in Q3 was 13.6% and for the full year, we expect the adjusted effective tax rate to be roughly 16.5%. Swiss tax reform results in one time --a one-time tax benefit in Q3. But increases, our effective tax rate going forward. So you should continue to expect the tax rate for TE to be in the high teens as we move beyond this year. However, importantly, we expect our cash tax rate to stay well below our reported [Phonetic] ETR, and if I can get you to turn to Slide 9, sales of $3.4 billion were down 5% year-over-year on a reported basis and down 3% organically.

Currency exchange rates, negatively impacted sales by $123 million versus the prior year. Adjusted operating margins were 17.6% and our strong margin performance despite lower sales, as a result of the benefits we are seeing from proactive cost actions we initiated earlier this year. As well as, the progress we have made in profitability across all the segments, particularly the industrial segment.

In the quarter, cash from continuing operations was $692 million and our free cash flow was $115 million with a $166 million of net capital expenditures we returned $307 million to shareholders through dividends and share repurchases in the quarter and year-to-date 2019, free cash flow is $928 million, which is an increase of 27% versus the prior year. We expect that our free cash flow will exceed the prior year even with the increase level of restructuring investment related to our cost initiatives. So powerful story there.

Our balance sheet is healthy. We expect cash flow to remain strong, which provides us the flexibility to utilize cash and support of organic growth investments to drive long-term sustainable growth, while also allowing us to return capital to shareholders and continue to pursue bolt-on acquisitions. I'm pleased with our team reacted quickly to pull the levers in our business model earlier in the year to help mitigate the impacts of weaker sales on our margin and EPS performance. But as you should expect we will continue to balance our structural cost actions with our long-term growth investments to ensure sustainability of our business model going forward.

So with that, I'll turn it back over to Terrence to cover guidance before we get into questions.

Terrence R. Curtin -- Chief Executive Officer

Thanks, Steve. And let me get into guidance, I'll start with the fourth quarter, which is on Slide 10. Now based on what we laid out and we're seeing in the end markets and the order trends. Fourth quarter revenue is expected to be $3.2 billion to $3.3 billion with adjusted earnings per share of $1.27 to a $1.33. At the midpoint, this represents lower year-over-year reported on organic sales of 7%. Even with the sales decline, we're only expecting year-over-year reduction of $0.05 and adjusted EPS on $250 million of lower revenue, which is evidence of the multiple levers we're pulling in our business model, including the accelerated cost actions Heath just talked to you about.

Looking at it by segment, we expect Transportation Solutions to be down mid-single digits organically and this is based upon a global auto production environment, which we expect to be down 6% in the quarter. With our revenue being impacted by supply chain adjustments in light of further weakening and production trends.

In Industrial Solutions, we expect to be down low-single digits organically with declines in industrial equipment from the inventory destocking being partially offset growth momentum in aerospace and defense and medical applications. And in communications, we expect to be down approximately in the high teens as the inventory destocking we mentioned works its way through and it will impact that segment more than the others.

Now turn to Slide 11, I'll get into the full-year guidance for '19. For the full year, we expect sales in a range of $13.35 billion to $13.45 billion. As, I mentioned earlier, this is a reduction of $250 million from our prior view due to lower auto production driven by China and inventory destocking in the distribution channel. Our guidance represents declines of 2% on an organic basis, and 4% on a reported basis with currency translation headwinds of $400 million on a full year basis. Adjusted earnings per share is expected to be in the range of $5.47 to $5.53 and this is a $0.10 reduction from our prior view. On a year-over-year basis, we are expecting adjusted EPS to be up low-single digits, excluding currency exchange headwinds of $0.16.

Similar to quarter four. Let me get into some color on our segments for the full year guide. We expect Transportation Solutions to be down low-single digits organically and we now expect global auto production to be down approximately 7% versus our prior view of being down 5% with the reduction primarily driven by China and certainly this is all on our fiscal period. Year-to-date, our revenue growth has exceeded auto production by the content growth range that we told you in the range of 4% to 6%. So our content position is very strong.

In Industrial Solutions, we continue to expect sales to be up low-single digits organically with growth driven by aerospace, defense, as well as, medical applications. And lastly in Communications, we do expect to be down high single-digits organically driven by the Asia market weakness that we've been talking about before this quarter as well as, the inventory destocking in the distribution channel that we're seeing that's impacting us here late in the year.

So with that, before we go into questions, let me just recap some key takeaways that I hope we can make during the call. First, we've seen weakening in the market, since the last call and this is driving the reduction in our guidance. It's driven by two main areas drop in auto production in China. As well as, what we're experiencing through our distribution partners, as they are destocking their inventories.

Secondly, we have position TE to benefit from secular trends such as electric vehicles, autonomous driving, next generation airframes, as well as interventional medical applications and cloud infrastructure growth, which are enabling us to outperform weaker markets.

Thirdly, despite this market backdrop. We are successfully executing on our strategy. Driving the multiple levers that we have in our business model to protect our margin and earnings performance through the cycle. And lastly goes without saying I think we've proven this when we've seen markets that are weaker in the past, we're going to take advantage of these holes as an opportunity to aggressively go after cost reduction and footprint consolidation activity. And we're following the same approach and expect to emerge with increased earning power when these markets return to growth.

So before I close, I do want to also thank our employees across the world for their execution in quarter three and what continues to be a mix market backdrop. And, as well as, their commitment to our customers and a future that is safer, sustainable, productive and connected.

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

Sujal Shah -- Vice President, Investor Relations

All right, thank you, Lisa. Can you please give the instructions for the Q&A session.

Questions and Answers:

Sujal Shah -- Vice President, Investor Relations

[Operator Instructions]. Your first question comes from Craig Hettenbach from Morgan Stanley, your line is open.

Craig Hettenbach -- Morgan Stanley -- Analyst

Yes, thank you. Question for Terrence, just given the backdrop that we're in, just wanted to get your thoughts kind of as you manage internally, you have a number of restructuring programs going on, but also externally are you still looking to kind of pursue and execute on M&A? And how you kind of balance those things? And what's kind of a difficult cycle?

Terrence R. Curtin -- Chief Executive Officer

No, I mean, couple of things I think. First of all, it goes back to -- we're very fortunate that we have a very strong cash generation model that you see it with the free cash flow, we generated. So, I don't think as we manage through both of these, as well as we return capital to owners, I don't think it's one versus the other. I think what's really nice about what we've done with our portfolio, you see how the content trends, where we positioned ourselves, well. You see it even how automotive contents buffering a recession in automotive production that we got a little bit of a head fake last quarter in China, that made it a little bit worse here. But, I do think when we look at what sensors and medical which our platform that we want to build on, as well as areas like Kissling that we talked about, that's an area where electric and how do we get into high-power and commercial transportation, we're going to continue to look for M&A opportunities that continue to build on where we have a very strong position.

So, I don't think it's one versus the other. And, I also believe when we get into our cost structure, I'm pretty pleased that we got after it early in the year. We've been sort of -- auto production has gotten worse. So we've had to expand some things to make sure we take the cost out during the law and even with what Heath talked about, what we're talking about, and some of the expanded is also making sure we're looking at maybe some opportunities in Communications at -- at higher volumes we probably couldn't take advantage of. The only other thing I would add is, I'm also very pleased that when you think about the adjustments we're making in the market, there is also things we teed up and the year before that we talked about -- about the Industrial segment. And you're really seeing how we continue to improve the performance of that segment, how it's contributing and there's still things that aren't from some of the investments we've made aren't having a payback yet. So, I think it provides future leverage as we fix the fixed cost structure of TE and get it better aligned and also little bit more agile. So, I think you're going to continue to see us balancing both of them and I think this quarter is a great example of it.

All right, thank you, Craig.

Sujal Shah -- Vice President, Investor Relations

Thanks Craig. We have the next question please.

Operator

Your next question comes from David Leiker from Baird. Your line is open.

David Leiker -- Robert W. Baird & Co -- Analyst

Hi, Good morning, everyone.

Terrence R. Curtin -- Chief Executive Officer

Hey, David. Good morning.

David Leiker -- Robert W. Baird & Co -- Analyst

I wanted to dig through a little bit of some of these headwinds, you're seeing in the channel it seems to be impacting you a little bit later than some other people, I want to understand, if we can, how your business going through that channel is different than other people and how long for your products as we go through those corrections in that channel. How long does it last for you to kind of work through that? Thanks.

Terrence R. Curtin -- Chief Executive Officer

Okay. So, David, I don't know what other products -- since you're talking about when you think through us of our $13.4 billion of revenue. There is a little bit over $2 billion that goes through our channel partners and it's really around the medium to small customers that we can serve directly and we do leverage our channel partners for that when you look at it and you sort of take that $2 billion. Our Transportation business is a very direct business.

So the channel impact is pretty small when it deals with our Transportation segment as you deal to the markets that have more fragmented customer basis, you get that in our industrial equipment area that's been impacted by it, you're also seeing it in our communication segment. And what we were seeing was actually our business through our channel partners have been staying pretty stable at around the orders were running around $500 million per quarter be up the last six quarters and this past quarter and the June quarter, it stepped down and we expected a step down even further.

And there's been some announcements out there, typically that's getting aligned more with the slowness of the market. As well as I think, we're also being impacted that some of the channel partners due to lead times and other product categories in certain semi-categories and passes probably got a little bit ahead of themselves and making sure they had enough supply that will being said these types of supply chain adjustments, while a headwind now typically take four to six months to sort of work through clearly we're in the middle of it. And, I think they are temporary effects. So they are something we're going to have to work through here over the next couple of quarters, and that'll be a tailwind at some point depending upon where markets are and we're in the middle of it. So while it may be later versus other categories, it is, we start to see it in the orders from quarter three, It will be with us for a little bit and then it will be a tailwind at some point when it corrects and get normalized.

David Leiker -- Robert W. Baird & Co -- Analyst

Thank you.

Terrence R. Curtin -- Chief Executive Officer

Okay. Thank you, David.

Sujal Shah -- Vice President, Investor Relations

Thanks, David. We'll have the next question please.

Operator

Our next question comes from the line of Shawn Harrison from Longbow Research. Your line is open.

Shawn Harrison -- Longbow Research -- Analyst

Good morning, Terrence.

Terrence R. Curtin -- Chief Executive Officer

Hey, Shawn. Good morning.

Shawn Harrison -- Longbow Research -- Analyst

The auto sector in terms of the step down here, particularly led by China. Are there any leading indicators that you're looking to track be it inventory, be it other factors within China or globally that will tell you, we've reached the bottom. And I'm not looking for you to guide the December quarter, but just to speak about it in some sense of whether we could reach the bottom end of the December quarter and calendar 20 could represent a more positive environment?

Terrence R. Curtin -- Chief Executive Officer

Sure. So as everybody heard us talk last quarter, we sort of, we were getting the stabilization in auto production and I think -- I've even said on this call or in some conversations at conferences, we sort of thought we were running around 22 million units of cars being produced per quarter, and we felt we were stabilizing. And to the comments I made on the call, what we actually saw in sort of you know, after earnings you saw China car sales were down mid, mid-teens and certainly that has impacted China auto production. And, I would tell you right now global automotive is running around 21 million units versus the 22 million units.

So that's impacted us by about 2 million units coming out. That all being said, we are looking at inventories in China, Inventory days on hand in China, in addition to the sales. They are around 50 days on hand, that's a little heavy. I wouldn't say it's horribly heavy, but they are the types of things, both on the car sales, as well as, the inventories, we're looking at. And right now, I would tell you we are sort of assuming that we're running around that 21 million unit rate. China typically has a step-up in the first quarter and production. Yes, I guess, that's the real uncertainty, I would say we weren't -- we have to continue to watch for the car sales and inventory levels are before we would tell you where we should be. But right now our [Indecipherable] model is sort of thinking there saying how do we plan the business around 21 million units globally per quarter in automotive's how we're thinking about it and also how we're adjusting our cost structure and some of the things, Heath talked about.

Sujal Shah -- Vice President, Investor Relations

Okay. Thank you, Shawn. We'll have next question please.

Operator

Our next question comes from the line of Wamsi Mohan from Bank of America, Merrill Lynch. Your line is open.

Wamsi Mohan -- Bank of America/Merrill Lynch -- Analyst

Yes, Thank you. Terrence, you opened the call talking about revenue growth and sort of some of the headwinds here in 2019. As we think about adjusting to these lower organic growth levels in fiscal '19. Can you maybe give us some sense of how we should think about heading into fiscal 21st quarter, how we should think about seasonality off of these lower fiscal 4Q levels? And how do you view the odds of continued headwinds going into fiscal 20?

Terrence R. Curtin -- Chief Executive Officer

Thank you for the question, Wamsi, this part of this, you know, I'm going to not answer, because we're not guiding to 20 yet, and certainly as we get more intelligence we will. I think there are some things that I would highlight though, to your question.

I think there will be things like auto production that -- that has been fluid. I think we're going to have to continue to keep fluid. But I would also say, when you think about that of this point, I sort of talked around -- and the $21 million units is we're still position ourselves around that 4% to 6% content element. So you've seen it this year even at while the market been worse , I think you're going to continue to see that.

So as we pick production points and do your analysis. I do think you're going to see those benefits around, transportation, certainly, you're going to see it in aerospace you're seeing it in medical. So I think that's first of all, but I would say as you work your miles is important.

I'll go second things probably going back to what David said, channel to stocking is a temporary item, and I think there is going be a lot of data points, not only by us, but there are some out there. This will normalize. So what is the headwind that we have in quarter four that will go into early next year.

Certainly, that will turn like it typically does. And the other thing I would just say as we go into next year and it's less revenue, as you know, there is lots of levers that we're pulling and where they hit in the year from a cost perspective, will be a different points depending upon we initiated. But I do think, as we try to manage through this. We have many cost levers that we're working that I think no different as we just displayed in quarter three and quarter four, we're going to continue to be working from an earnings perspective. Now that being said, there is a sub-point in your question around how do we see seasonality. Let's face it. This year, seasonality was not normal. Quarter three and quarter four are typically our strongest quarters of the year and quarter four is already going to be our weakest. So, I don't think you can take the normal seasonal patterns that we have and say you know, take quarter one is going to be down mid-to-high single digits in the quarter four. I think you have to -- just for some of these facts as you look at that. And certainly will guide more as we talk to you in 90 days, but I would just not say go blind seasonality, because these markets aren't typical either. So longer answer than probably you wanted, but hopefully that gives you some insights as you think about things. And we'll give you more input in 90 days.

Sujal Shah -- Vice President, Investor Relations

Okay. Thank you, Wamsi. We have the next question please.

Operator

Our next question comes from the line of Scott Davis from Melius Research. Your line is open.

Scott Davis -- Melius Research -- Analyst

Hey, good morning guys.

Terrence R. Curtin -- Chief Executive Officer

Hey, Scott.

Scott Davis -- Melius Research -- Analyst

I know this might be hard to to answer. And, I know you're not giving 2020 guidance. But can you help us give a little granularity on the restructuring. And as far as kind of payback is sometimes you do restructuring in Europe, and it takes a few years to see an impact, but you do it in the US and its immediate. Can you just help us understand either directionally or an actual kind of tailwind for 2020 would be helpful. Or at least some color around where the restructuring is?

Terrence R. Curtin -- Chief Executive Officer

Super. I will let Heath.

Heath Mitts -- Executive Vice President and Chief Financial Officer

Scott, I think you're, you're right on terms of that some of the non-US restructuring does have a longer cash-on-cash return. In addition to the -- just the length of time too when you're taking factories offline, to from the point of initiation tell you when you realize in the savings. I think it's fair to say of that $375 million, there is a blend, but on average it's about three to four-year payback. So that would kind of steer you toward a number of annualized savings as part of that and steer you toward jurisdictionally where a lot of this activity is taking place.

Scott Davis -- Melius Research -- Analyst

Okay, thank you guys.

Sujal Shah -- Vice President, Investor Relations

Thanks, Scott.

Terrence R. Curtin -- Chief Executive Officer

Thanks, Scott.

Sujal Shah -- Vice President, Investor Relations

We have the next question please.

Operator

Our next question comes from the line of Mark Delaney from Goldman Sachs. Your line is open.

Mark Delaney -- Goldman Sachs -- Analyst

Yeah. Good morning and thanks for taking the question.

Terrence R. Curtin -- Chief Executive Officer

Hey, Mark.

Mark Delaney -- Goldman Sachs -- Analyst

I was wondering you could drill a little bit more into China region specifically. And with the decline in orders that you saw there and the reversal compared to what you've been seeing last quarter, is that all just macro and weakness? Or do you think any of this is due to the trade environment and potentially a more difficult region for US company to do business now? Thanks.

Terrence R. Curtin -- Chief Executive Officer

So a couple of things. Certainly the global trade environment, I think just creates an overlay around economic conditions period, I don't think it's only one or two countries it impacts everything, so I do think that has some impact on the slower economic conditions because places like Europe ships into China and so forth and that impacts us in many places and more back to the question that you had when we were sitting here last quarter, we saw a nice increase in our China business, our orders went up almost 10% going from our first quarter, second quarter and it was primarily driven by transportation and it did revert back. I would say in our industrial businesses it has stayed steady at a constant rate. I wouldn't say it's accelerating but it's sideways. So in those our industrial businesses, it's staying steady, and is more flat year-on-year, but auto has been the big,-- bigger piece for us as that production has declined. I don't think when it comes to automotive and our position we have in automotive.

I don't think it is impacted by our US attachment. The other thing I would say, the places that I would say have gotten, a little bit weaker is around the communication equipment, that's an area and also in appliances and [Phonetic] CS we've been talking about that all year. There have been environments where they have been slow so in the industrial space, it's been more stable and sideways, but really the slowing we saw versus last quarter is really in our Transportation and Communications segments. Not as much our industrial space.

Sujal Shah -- Vice President, Investor Relations

Okay. Thank you, Mark. We have the next question please.

Operator

Our next question comes from the line of Joe Giordano from Cowen. Your line is open.

Joe Giordano -- Cowen -- Analyst

Hey guys, Good morning.

Terrence R. Curtin -- Chief Executive Officer

Hey Joe.

Joe Giordano -- Cowen -- Analyst

I know, it's hard to do for you guys. But is there any way to kind of at least triangulate how much you think on the communications jam up on the supply side is, is due to like very specific temporary issues with like [Phonetic] Wallway and restrictions on certain entities.

Terrence R. Curtin -- Chief Executive Officer

I would tell you when we think about the supply side of that. I don't think channel has anything to do with that. Our channel business -- large customers, we service directly so when you sit there and the portfolio set in our communication segment is a portfolio, said that goes into a lot of different applications, not just high speed and is why it does have a big part to go through the channel there in both our appliance business and our [Phonetic] DND business their basic building blocks that can be used in a lot of different areas.

So when, to try to tie what's going on with the channel to telecom China. I think that would be a lead too far. Obviously, we're also seeing it in industrial and our industrial markets as well. I'm sorry, Joe.

Joe Giordano -- Cowen -- Analyst

Yes, obviously it's like an indirect route. I'm just curious if there was any way to kind of like close that loop there?

Terrence R. Curtin -- Chief Executive Officer

No, I mean, I think the other thing that you have. I don't think you can close that was there.

Joe Giordano -- Cowen -- Analyst

Okay.

Terrence R. Curtin -- Chief Executive Officer

There has been some slowness by certain other telecom equipment makers and certainly cloud spending, which was very strong growth last year, it's still growing, but at a lower rate. There is lots of those other factors that I would also say, impact that, but I wouldn't tie it completely back to Huawei.

Joe Giordano -- Cowen -- Analyst

Thanks.

Sujal Shah -- Vice President, Investor Relations

Okay. Thank you, Joe.

Terrence R. Curtin -- Chief Executive Officer

Thanks, Joe.

Sujal Shah -- Vice President, Investor Relations

We have the next question please.

Operator

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

Christopher Glynn -- Oppenheimer -- Analyst

Yes, thanks, good morning. The -- the headline China numbers are one story, but maybe electric vehicles look different story. I think it's up about 50% year-to-date. Just wondering if that aligns with that -- you're thinking do you expect that penetration to accelerate. What are your learning along that curve from your kind of specification cycles with the customers there?

Terrence R. Curtin -- Chief Executive Officer

Certainly. While China auto production is down electrical vehicle penetration you're exactly right. If you look at it, if you take full -- full electric plus any hybrid it continues to accelerate even though China car production is down, so that is not changing, certainly it's growing while overall production is down and our design wins around those electric vehicle continue to be very strong. And let's face it, it is something when we think about electric vehicles, electric vehicles are going to be driven in the world by both China and Asia as well as, the CO2 requirements that you have in Europe as well. So when we think about electric vehicles the place you need to be positioned and we are positioned very strongly is in Europe, it is in China, as well as you know, in Japan and what's really good is we're positioned well with our customers. And the one thing that we always watch in slow markets is where is our project momentum, do we see project momentum slowing? We are not seeing any change in the number of projects we have with our customers in any of our businesses. And certainly in the automotive space, there continues to be the march between electric vehicles and autonomous features by all our customers that serve those markets.

So we don't see any change in that. Certainly, the global production is impacted that, that's more impact combustion engines.

Sujal Shah -- Vice President, Investor Relations

Okay. Thank you, Chris. We have the next question please.

Operator

Our next question comes from the line of Jim Suva from Citigroup Investment. Your line is open.

Jim Suva -- Citigroup Investment -- Analyst

Thank you very much.

Terrence R. Curtin -- Chief Executive Officer

Hey Jim

Jim Suva -- Citigroup Investment -- Analyst

And very clear on the automotive side, which is good. But the communication side, you saw a few questions. And when we think about that, If my memory is correct, you're really not a smartphone supplier or component of smartphone. So I assume this is more or like on base stations, routers, switches, those type of bigger box, bigger devices and with 5G build out, I guess I'm a little surprised to see this type of slowdown. So can you help us. Can we see a order, build up like last quarter, in excess of end demand or is it just a trade wars for people overstock and other destocking or was it truly an end market demand slow down in the communications segment? Thank you.

Terrence R. Curtin -- Chief Executive Officer

Hey, Jim. Twofold and you're breaking up a little bit on your cell. So first of all, I would say when you think about our communication segment, there is a chunk of it, which is data and devices and then there is another chunk about appliance. So certainly we can -- we need to look at, to your question of that devices. You're right, we do not plan smartphones, so our products go into base station equipment goes into traditional switches like you mentioned. And when you look at it, what we've seen is we have seen some of the cloud spending not growing as fast as rate as it grew last year. So when you're talking about something that grew 20%, 30% of spending, and it grows 10% you will have adjustments in supply chain, I do think that is working through.

On 5G, 5G when you think about it, certainly we're designed in and China is granting licenses and we are positioned very well there, but that is still early stages of how much does that contribute to TE's revenues. So their typical growth drivers, we're going to get the benefit from, so both around cloud and 5G, we're in good shape. The other thing I would just say around our [Phonetic] D&D and it goes back to the channel comment I made. Typically our products in [Phonetic] D&D are very much next to semiconductors and passes. I do think, some of our partners and also other Tier ones in the supply chain probably got a little bit ahead of themselves as you said, and they are correcting to get to more normalized to end demand. It has, -- this is not a content or share element, it's more of, we're going to get hurt here a little bit with the inventory destocking, but that will normalize and I feel very good about where we're positioned in cloud and 5G but certainly, we don't plan cellphones.

Sujal Shah -- Vice President, Investor Relations

Okay. Thank you, Jim. We have the next question please.

Operator

Our next question comes from the line of David Kelley from Jeffries. Your line is open.

David Kelley -- Jefferies -- Analyst

Thanks. I just have a quick follow-up on your earlier comments on China vehicle inventory levels. If we were to see some hypothetical vehicle demand injection in China, can you talk about your ability to ramp back up to support production growth given your presumably running leaner with ongoing cost actions? I think clearly, no one is ready to call

Heath Mitts -- Executive Vice President and Chief Financial Officer

Yet, but we're just trying to get a feel for it. There might be an operational lag an impact on short-term margins when production does ultimately rebound.

Terrence R. Curtin -- Chief Executive Officer

Clearly we're as we do the actions that Heath talked you about. We are also been very focused of how in those core areas that we keep production flexibility. And what we had was, in some cases, we were playing catch up as the volume is going very strong. We talked about last year. We feel we have enough capacity. If we do get a jump back in there. It might be a little bit of a lag. But we feel very good with how not only what we do, but also our extended supply chain can do. So that is not something we worry about and certainly if it came back stronger than we thought, we would also have to look at how we time some of the restructuring actions that Heath talked about.

Sujal Shah -- Vice President, Investor Relations

Okay. Thank you, David, we have the next question please.

Operator

Our next question comes from the line of Deepa Raghavan from Wells Fargo Securities. Your line is open.

Deepa Raghavan -- Wells Fargo Securities, LLC -- Analyst

Good morning all.

Heath Mitts -- Executive Vice President and Chief Financial Officer

Good morning Deepa.

Deepa Raghavan -- Wells Fargo Securities, LLC -- Analyst

Heath, I think it's a question for you, how do we think about contribution margins? Given that the weakness in markets will be offset by some of the cost actions you seem to be taking new actions in every few quarters now. What should we expect the average contribution margin to net out on the corporate average line broadly and how does it compare across segments like above, below corporate average? I think that will help us reset, some of our expectations. Thank you.

Heath Mitts -- Executive Vice President and Chief Financial Officer

Well, thanks for the question Deepa. let's just. Let's take a bigger view of this first. Right. I mean we've seen demand tick down pretty considerably throughout the year on auto production and Terrence said it's kind of settled in around $21 million vehicles a quarter which is in a run rate that's pretty significantly less than will be in around prior years. That avails us the opportunity to get after some things on the cost structure or transportation maybe in jurisdictions that we can better align with new locations, lower cost locations and so forth closer to where our customer supply chain exist. So that's a real opportunity for us on that front.

And then Communications is the other area that we have, we're going to do some restructuring in as you'll recall, transportation for the first half of our fiscal year was running quite strong. We've seen based on all the comments made earlier in this call as that's ticked down is pulled forward some things that we would have done, maybe in future year's anyway. And so, as we're starting to look at those types of actions you'll start to see closer margin flow through. Our normal larger flow-through is between 25% and 30%. I will tell you that when you see the types of numbers specifically within Communications drop at that rate, it's going to take a little while to get back to those types of contribution margins I just mentioned, because you're still having to cover fixed cost and so forth. Having said that, I don't want to get too hung up on percentages here because being CSP our smallest segment, we could be talking about a few million dollars swing a percentage more dramatically than really to total what the real material impact is to TE. So, I think we've got to be careful with that.

Now industrial is, we've talked pretty openly about industrial being on a multi-year journey to come out of this -- to work its way toward the high teens. I would tell you that we're probably a little ahead of plan, and what we went into the year with went into the year assuming that our industrial margins would be roughly flat while we execute on some footprint moves that have been announced and we're actively working through, but the team has done a really good job of getting some of those savings out a little bit faster than planned. In addition to just kind of normal belt tightening.

And so I feel good about that in terms of that I'd say industrial is still got -- still has a couple of years left of things of activity that's doing based on the timing of some footprint moves. And so we're continuing on that journey in terms of that. So, I mean if you kind of back up from all of that, we're really using this opportunity in this part of the cycle to get out fixed cost, that's why we've lowered the overall restructuring and come out of this when market demand does improve, we'll have a leaner structure and obviously it's harder to do this one time when we were in periods of higher growth.

So I hope that answers your question. But happy to take any follow-on.

Sujal Shah -- Vice President, Investor Relations

Okay, thank you. Deepak. We have the next question please.

Operator

Our next question comes from the line of Steven Fox from Cross Research. Your line is open.

Steven Fox -- Cross Research -- Analyst

Thanks, good morning. I'd like to follow up on...

Terrence R. Curtin -- Chief Executive Officer

Hey, Steve.

Steven Fox -- Cross Research -- Analyst

Hi, I guess the confusion, I have in terms of all the charges, you've taken say, over the even year -- last year or two, last five years is trying to discern tactical from strategic you made a good case for why industrial is strategic. But in the case of some of these latest charges, how do we know that you're not sort of coming into the bone a little bit too much as opposed to fat. And how do we see an end to sort of the charges if demand stays sort of at these levels? Thanks.

Terrence R. Curtin -- Chief Executive Officer

I think Steven, first of all, I think it's fair question and we have as the business has evolved. We have continued the journey on the footprint side of things as you mentioned, I think industrial is pretty clear in terms of what we laid out here in the last 18 to 24 months and where we are in that journey and you've seen those in the numbers. Certainly, there is some tactical things that we will be doing within the CS business, but again it's the smaller segment and I don't want to get too hung up on a margin rate there in terms of what the target is, we performed very well in that segment. But a couple million dollars can swing you from mid-teens to low-teens or the other direction, too high-teens. So, I want to be careful in terms of that. What we're doing on the transportation side it more meres what we're looking at from industrial, which is taking advantage of this, these are, these are locations that on a clean piece of paper, we would probably not have in those jurisdictions anyway. So this is more of a couple of your journey in terms of that process to get the operating footprint where it needs to be, I'm not worried about cutting into bone. And I say that because the long-term business model and all the trends that we enjoy, whether it's on the auto side with hybrid and electric or the overall factory automation side with an industrial and everything, all the great stuff is going on in medical or aerospace and defense.

There is nothing that we're going into, in terms of cutting that we don't have redundant capabilities or opportunities to move into existing locations, we are not having to go do a bunch of greenfield to do this and we're not taking a lot of cost out of high growth-- higher growth areas through a cycle like places in Asia and so forth where we do expect for instance hybrid and electric to be a more prominent piece there.

So as I look at it, I'm not worried about cutting them to there. I view this is more of an opportunity to get some things done that would be harder to do if we're at a higher growth environment because in those cases you're just trying to keep up with customer demand.

Steven Fox -- Cross Research -- Analyst

Great. That's very helpful. Thank you very much.

Sujal Shah -- Vice President, Investor Relations

Thanks. Thanks. Thanks, Steve. We've the next question please.

Operator

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

William Stein -- SunTrust Robinson Humphrey -- Analyst

Great, thanks for taking my question. If we think about the below seasonal trend that we're seeing guided for in Q3 overall, I wonder if we could hear your take on the trends, if you were to allocate them to the direct business versus the channel, how much of the weakness in the channel and how much of the direct business might have been much closer to seasonal if we're to look at it carved up that way. Thank you.

Terrence R. Curtin -- Chief Executive Officer

Well, let me talk directionally. So a couple of things, I highlighted our book-to-bill overall as a company with 0.98, and in our channel, it was 0.85. So I do think channel has been a steeper impact and we've talked about it, but you do sit there and you know there has been slowness -- auto production slowness has nothing to do with the channel. So, I think when we talk about how we frame the reduction in guidance, two-thirds was driven by transportation and a slower China and certainly seasonally, I do think that's abnormal that China, would have weakened in the quarter we're in. But the other one-third is truly the channel that 250 decline. So it's different by market, but I would say channel correction happens due to them adjusting to end markets that are happening. And clearly, they're seeing some slowness. So that it is deeper in the channel. Certainly that's an impact, we're going to have here, like I said not only in the quarter four or probably go into early next year. But certainly, we've seen a slowness in our direct customers as well. But not to the extent as channel.

William Stein -- SunTrust Robinson Humphrey -- Analyst

Thank you.

Sujal Shah -- Vice President, Investor Relations

Thank you, Will. Can we have the next question please.

Operator

[Operator Instructions] Our next question comes from the line of Matt Sheerin from Stifel. Your line is open.

Matt Sheerin -- Stifel -- Analyst

Yes, thank you. Just another question on the Industrial Solutions segment, specifically the strong growth that you're seeing in the military aerospace and marine sector, which has been up double digits. What are the drivers there, Terrence? And what's the outlook? I know we've heard from other suppliers that the defense and aerospace market continues to be strong. I know there's also some distribution exposure there too, It doesn't sound like there is inventory issues there? And then just on the margins -- Heath, you did talk about the drivers of that really strong margin expansion year-over-year, but given and so I guess one question is the mix of business, the stronger Mil-Aero is that a contributor to margins, or is it mostly the cost cutting actions that you talked about?

Terrence R. Curtin -- Chief Executive Officer

So let me take the first half, and I'll let Heath take the second half. So one of the things that we talked to you all about for a long time is how we position ourselves very well from around commercial aerospace and certainly the [Phonetic] content opportunity we have there and we've laid that out our you both on what happens and two aisles, single aisles and also regional jet. And while airframe production, it has been pretty stable, but I think you really seeing the benefit in the commercial aerospace side from those content momentum that we've had very broadly across the industry, and it's really a credit to our team, that's really long cycle.

In addition, this year we are getting the kicker about defense spend. And I think similarly, while defense and I think it's pretty obvious when you looked at defense companies, they are in a good cycle, but it's also an area that we do have a nice position, our position between commercial aerospace and defense is pretty balanced and we're getting the benefit on both sides and Defense is also driven by government spendings, and we're benefiting from that. But that is also a content play as well. When you think about communications, you think about power distribution and all the next generation hardware that's gone on defense. We benefit from that as well. And that's a content play. So those two are very important to your point, Matt. Part of that business does go through the channel. That is not seeing destocking that is a market that still seeing very good there. And you know is one of the things that's buffering in the Industrial segment.

The slowness that we have to do the destocking our Industrial Equipment business in the channel. So I'll let Heath, talk about the margin side of it.

Heath Mitts -- Executive Vice President and Chief Financial Officer

Yes, Matt, I appreciate the question. So on the margin side, when I think about Industrial and we're internally going through our processes. There's not a tremendous amount of mix that plays into it. There's certainly some pieces that have a little bit better flow-through in terms of particular product lines and so forth within each individual business unit. But I think it's pretty well balanced in terms of, we make a little bit more money in certain areas, a little bit less than others, but it's not a wide swing there. In terms of, as you can imagine, obviously, I think part of your question was the aerospace defense we're obviously when you're growing the type of organic numbers that we're seeing out of our aerospace defense business, you would expect nice flow through and we are certainly seeing that and the business is converting the revenue and the profits nicely as you would expect them as they blow past some of their fixed cost base.

But there's other areas as well that are showing some resiliency on the margins, particularly our energy business, as they have initiated and nearly concluded of some facility restructuring. So there is a lot of different moving parts there it's a balance between where the growth is as well as some of the footprint consolidations. We had talk some earlier in the year about this being a year where they're not going to be as much, I'd say we're a little ahead of our sales. As I mentioned earlier in the call and we'll still see some periods from time-to-time a quarter or two, where you'll see a jump down a little bit as you have duplicative costs, meaning you're moving out of one facility into another and you might have to duplicative cost for a period of a quarter or so during any particular facility rationalization, so that will happen from time-to-time, but we're very pleased with the progress that the team is doing and what the, what their current outlook is as they move forward.

Sujal Shah -- Vice President, Investor Relations

Okay. Thank you, Matt. And I'd like to thank everybody for joining us this morning for our call. If you have any additional questions please contact Investor Relations at TE. Thank you and have a nice day.

Operator

Ladies and gentlemen, your conference will be made available for replay beginning at 10:30 AM Eastern Time today, July 24th on the Investor Relations portion of the TE Connectivity's website. That will conclude your conference for today.

Duration: 73 minutes

Call participants:

Sujal Shah -- Vice President, Investor Relations

Terrence R. Curtin -- Chief Executive Officer

Heath Mitts -- Executive Vice President and Chief Financial Officer

Craig Hettenbach -- Morgan Stanley -- Analyst

David Leiker -- Robert W. Baird & Co -- Analyst

Shawn Harrison -- Longbow Research -- Analyst

Wamsi Mohan -- Bank of America/Merrill Lynch -- Analyst

Scott Davis -- Melius Research -- Analyst

Mark Delaney -- Goldman Sachs -- Analyst

Joe Giordano -- Cowen -- Analyst

Christopher Glynn -- Oppenheimer -- Analyst

Jim Suva -- Citigroup Investment -- Analyst

David Kelley -- Jefferies -- Analyst

Deepa Raghavan -- Wells Fargo Securities, LLC -- Analyst

Steven Fox -- Cross Research -- Analyst

William Stein -- SunTrust Robinson Humphrey -- Analyst

Matt Sheerin -- Stifel -- Analyst

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