TE Connectivity Ltd. — Q1 Fiscal 2020 10-Q
Business context and reporting period: This unaudited quarterly filing covers the quarter ended December 27, 2019, compared primarily with the quarter ended December 28, 2018. TE Connectivity is a global connectivity and sensor solutions company with Transportation Solutions, Industrial Solutions, and Communications Solutions segments. Amounts below are in U.S. dollars.
Key financial results
| Metric | Q1 FY2020 | Q1 FY2019 |
|---|---|---|
| Net sales | $3.168 billion | $3.347 billion |
| Gross margin | $1.030 billion; 32.5% | $1.114 billion; 33.3% |
| Operating income | $471 million; 14.9% margin | $484 million; 14.5% margin |
| Income from continuing operations | $23 million | $383 million |
| Net income | $26 million | $276 million |
| Diluted EPS | $0.08 | $0.80 |
| Cash from continuing operations | $411 million | $328 million |
- Sales declined 5.3% year over year; organic sales declined 4.8%. Foreign currency translation reduced sales by $43 million, while acquisitions added $25 million. Price erosion reduced organic sales by $41 million.
- Gross margin fell 0.8 percentage points, primarily from lower volume and price erosion, partly offset by lower material costs. Operating margin increased 0.4 points; lower restructuring charges helped offset weaker sales and volume.
- Income tax expense was $447 million, including a $355 million charge principally from Swiss tax reform and the write-down of deferred tax assets following lower enacted cantonal tax rates. The reported effective tax rate was 95.1%.
- Prior-year results included a $107 million after-tax loss from discontinued operations, mainly the SubCom sale loss. Current-quarter discontinued operations contributed $3 million; continuing-operations figures offer the more direct operating comparison.
- Operating cash flow was $411 million; capital expenditures were $176 million. The resulting $235 million operating-cash-flow-less-capex figure is a simple calculation, not a company-reported non-GAAP measure. Operating cash flow improved mainly because of lower income-tax and incentive-compensation payments.
Financial position and liquidity
- At December 27, 2019, cash and equivalents were $742 million, versus $927 million at September 27, 2019. Current assets were $5.566 billion and current liabilities $3.404 billion; the calculated current ratio was approximately 1.64.
- Total reported debt was $3.973 billion, comprising $561 million short-term and $3.412 billion long-term debt. Net debt after cash was approximately $3.231 billion, calculated from reported balances. Operating lease liabilities of $519 million are separately reported.
- The company had no borrowings under its $1.5 billion revolving credit facility and reported compliance with debt covenants. The facility’s leverage covenant is triggered if consolidated total debt to EBITDA exceeds 3.75 to 1.0.
- Cash declined by $185 million during the quarter, reflecting $314 million of financing outflows, including $154 million of dividends and $139 million of share repurchases, and $289 million of investing outflows, including acquisitions and capital spending.
Material changes and segment performance
- Transportation Solutions: Sales declined 5.9% to $1.868 billion; operating income fell to $316 million from $332 million. Organic declines affected automotive, commercial transportation, and sensors, with commercial transportation particularly weak.
- Industrial Solutions: Sales were nearly flat at $927 million; operating income rose to $115 million from $100 million. Growth in aerospace, defense, oil and gas, medical, and energy was offset by a 15.0% organic decline in industrial equipment.
- Communications Solutions: Sales declined 13.9% to $373 million; operating income fell to $40 million from $52 million. Data and devices and appliances both weakened, amid distributor inventory and broader market softness.
- Restructuring charges declined to $24 million from $75 million. TE Connectivity repurchased approximately 2 million shares for $143 million, compared with approximately 6 million shares for $495 million a year earlier.
Outlook, risks, and unusual items
- For Q2 FY2020, management expected sales of $3.1–$3.3 billion, versus $3.4 billion in Q2 FY2019, and diluted continuing-operations EPS of $1.05–$1.11. It anticipated sales declines across all segments.
- For FY2020, management expected sales of $12.85–$13.25 billion and diluted continuing-operations EPS of $3.23–$3.53. The outlook included estimated foreign-exchange headwinds of about $209 million in sales and $0.11 per share for the year; Q2 headwinds were estimated at $77 million and $0.04 per share. Forecasts assumed exchange rates and commodity prices remained near then-current levels.
- Management cited global economic and cyclical market weakness, especially in automotive and industrial equipment, high distributor inventories, pricing pressure, foreign exchange, and raw-material costs as relevant risks. It said it was managing costs and believed operating cash generation and potential funding sources would cover anticipated capital needs.
- Fiscal 2020 restructuring actions were expected to produce about $20 million of annualized savings by the end of FY2022. Management expected total FY2020 restructuring charges of $200–$250 million and spending of approximately $220 million.
- Two businesses were acquired for $112 million net of cash acquired. The company also expected to complete its First Sensor AG transaction in FY2020, subject to customary conditions and outstanding regulatory approvals; the stated transaction value was approximately €330 million, including assumed net debt.
- SubCom-related performance guarantees and letters of credit totaled approximately $1.2 billion and may remain outstanding through FY2025. The company has contractual recourse and said it did not expect to have to perform; no new post-sale SubCom guarantees were outstanding at quarter-end. Environmental remediation exposure was estimated at $14–$45 million, with $18 million accrued.
- Adoption of lease accounting added approximately $520 million of right-of-use assets and related liabilities; management said adoption did not materially affect earnings or cash flows. No material changes to reported risk factors or market-risk exposures were disclosed.
Important facts for investors to verify
- Confirm the size and accounting basis of the $355 million Swiss tax-reform charge and its effect on deferred tax assets and reported EPS.
- Assess whether the forecast sales declines, distributor inventory levels, and automotive and industrial-market weakness persist or change.
- Track gross-margin recovery, pricing and volume trends, and whether restructuring savings are achieved against expected charges and cash spending.
- Review cash conversion, working-capital movements—particularly the $176 million inventory cash use—and the funding of acquisitions, dividends, repurchases, and debt maturities.
- Monitor First Sensor closing conditions and the continuing exposure and recourse arrangements for SubCom guarantees.