TE Connectivity Ltd. — Form 10-Q Summary
Business context and period: Global connectivity and sensor products manufacturer. Fiscal third quarter ended June 28, 2019; comparisons are with the quarter ended June 29, 2018. The filing also reports the first nine months of fiscal 2019. Amounts are in U.S. dollars.
Financial performance
| Metric | Q3 FY2019 | Q3 FY2018 | First 9 months FY2019 | First 9 months FY2018 |
|---|---|---|---|---|
| Net sales | $3.389B | $3.581B | $10.148B | $10.479B |
| Gross margin | $1.110B; 32.8% | $1.187B; 33.1% | $3.342B; 32.9% | $3.563B; 34.0% |
| Operating income | $520M | $554M | $1.534B | $1.761B |
| Net income | $757M | $454M | $1.472B | $904M |
| Diluted EPS | $2.23 | $1.29 | $4.32 | $2.55 |
| Continuing operating cash flow | Not provided separately for quarter | Not provided separately for quarter | $1.575B | $1.379B |
Q3 sales fell 5.4% year over year (organic decline 2.8%); nine-month sales fell 3.2% (organic decline 0.5%). Currency translation was a major factor in reported sales declines. Q3 operating margin was 15.3%, versus 15.5%; nine-month margin was 15.1%, versus 16.8%. The higher reported net income largely reflects unusual tax benefits, not stronger operating income: Q3 included a $245M income tax benefit, including $214M associated with Swiss tax measures and $93M from effective settlement of a non-U.S. tax audit.
Q3 segment sales and operating income: Transportation Solutions, $1.968B and $308M; Industrial Solutions, $1.005B and $156M; Communications Solutions, $416M and $56M. Transportation and Communications sales declined; Industrial sales grew. Segment operating income declined in Transportation and Communications, but increased in Industrial.
Liquidity, cash flow, and capital
- Cash and cash equivalents were $546M at June 28, 2019, down from $848M at September 28, 2018. Total debt was $4.036B, compared with $4.000B at fiscal year-end; reported short-term and long-term debt were $602M and $3.434B.
- Nine-month operating cash flow was $1.544B including discontinued operations; continuing operating cash flow was $1.575B. Capital expenditures were $570M, implying approximately $1.005B of continuing operating cash flow after capital expenditures.
- The company had no commercial paper outstanding or borrowings under its $1.5B revolving credit facility at quarter-end. The facility matures in November 2023; the company reported compliance with debt covenants.
- Cash returned to shareholders in the first nine months included $454M of dividends and $913M of share repurchases. The board increased the repurchase authorization by $1.5B; $1.7B remained available at quarter-end.
Material changes, outlook, and commentary
- Management forecast Q4 FY2019 sales of $3.2B–$3.3B and diluted EPS from continuing operations of $0.81–$0.87. Full-year FY2019 sales guidance was $13.35B–$13.45B and continuing-operations diluted EPS guidance was $5.42–$5.48.
- Management cited automotive weakness, especially in China and EMEA, and high distributor inventories affecting industrial equipment, data and devices, and appliances. It expected global automotive production to decline about 6% in Q4 and 7% for FY2019. Currency was expected to reduce FY2019 sales by approximately $400M and EPS by $0.16 versus FY2018.
- Restructuring charges were $184M for the first nine months, including $179M for fiscal 2019 actions. Management raised expected FY2019 restructuring charges from approximately $250M to $375M, with expected cash spending of about $165M. Annualized savings of approximately $145M are expected by the end of FY2021.
- The company sold its SubCom business for $297M net cash proceeds and recorded an $86M pretax sale loss. It also announced an intended tender offer to acquire First Sensor AG, with completion expected in FY2020.
- Swiss tax reform produced a $214M tax benefit in Q3. Management expected to record approximately $300M of tax expense when cantonal changes are enacted, expected in FY2020.
Risks, contingencies, and unusual items
- Following the SubCom sale, TE Connectivity remained responsible for certain existing performance guarantees and letters of credit totaling approximately $1.7B; most were expected to expire within two years, with expirations through FY2025. The company may also need to issue up to $300M of new guarantees for certain future SubCom projects; none were outstanding at quarter-end. Management cited contractual recourse and did not expect to have to perform.
- Environmental investigation and remediation costs were estimated at a reasonably possible range of $15M–$44M; $18M was accrued. The company reported $316M of other outstanding letters of credit, guarantees, and surety bonds.
- Management identified macroeconomic and cyclical conditions, automotive demand, pricing pressure, raw-material costs, foreign exchange, customer and supplier conditions, acquisitions and divestitures, cybersecurity, litigation, and regulatory and tax changes as risks. It reported no material changes to previously disclosed risk factors.
- Adoption of the lease accounting standard in FY2020 was expected to materially affect the balance sheet, but not materially affect operating results or cash flows.
Important facts for investors to verify
- Whether sales and operating margins stabilize, particularly in Transportation and Communications, and whether distributor inventory levels normalize.
- How much of the reported earnings increase is attributable to the Q3 tax benefits, and the timing and amount of the anticipated Swiss tax expense.
- Execution, cash costs, and realized savings from the expanded restructuring program.
- Potential exposure, duration, and recourse arrangements for SubCom-related guarantees.
- Cash generation and debt levels alongside dividends, share repurchases, capital spending, and the planned First Sensor acquisition.