TE Connectivity Ltd. — Q3 FY2018 Form 10-Q
Business context and period. TE Connectivity is a global connectivity and sensor solutions manufacturer. This unaudited report covers the quarter ended June 29, 2018, and the first nine months of fiscal 2018; comparisons are with the corresponding fiscal 2017 periods. Amounts are in U.S. dollars.
Financial performance and key metrics
- Q3 revenue: $3.764 billion, up 11.8% year over year; organic growth was 6.2%. Currency added $131 million and acquisitions $59 million. Nine-month revenue was $10.989 billion, up 13.8%, including 7.0% organic growth.
- Profit: Q3 operating income was $558 million versus $544 million; net income was $454 million versus $435 million. Nine-month operating income rose to $1.763 billion from $1.520 billion, while net income fell to $904 million from $1.249 billion, principally due to the Tax Cuts and Jobs Act charge.
- Margins: Q3 gross margin was 32.3%, down from 33.9%; operating margin was 14.8%, down from 16.2%. Nine-month gross margin was 33.1%, down from 34.3%, while operating margin improved to 16.0% from 15.7%.
- EPS and dividends: Q3 diluted EPS from continuing operations was $1.29, compared with $1.21. Nine-month diluted EPS was $2.56 versus $3.47. Dividends paid per share were $0.44 for Q3 and $1.24 for the nine months.
- Cash flow and investment: Nine-month operating cash flow was $1.527 billion, up from $1.449 billion. Capital expenditures were $686 million versus $452 million, implying approximate operating-cash-flow-minus-capex of $841 million, compared with $997 million. Cash declined to $770 million from $1.218 billion.
- Debt and liquidity: Total debt was $4.008 billion, down from $4.344 billion; cash was $770 million. Current assets of $5.941 billion exceeded current liabilities of $4.046 billion (current ratio approximately 1.47). The company had a $1.5 billion revolving credit facility with no borrowings and reported compliance with debt covenants. $325 million of notes and €100 million borrowed under an uncommitted facility were due in December 2018.
- Capital returns: The company repurchased approximately 6 million shares for $612 million and paid $435 million in dividends during the first nine months. Remaining repurchase authorization was approximately $1.4 billion.
Material changes versus prior comparable periods
- Transportation Solutions led growth: Q3 sales rose 19.7% and nine-month sales 20.8%; nine-month operating income increased to $1.242 billion from $986 million.
- Industrial Solutions sales rose 9.2% in Q3 and 11.3% year to date. Q3 operating income declined to $93 million from $100 million, while nine-month income increased to $321 million from $258 million.
- Communications Solutions sales declined 4.7% in Q3 and 2.1% year to date; operating income fell to $71 million from $111 million in Q3 and to $200 million from $276 million year to date. Subsea communications weakness, including program production delays, was the principal drag.
- Price erosion reduced organic sales by $55 million in Q3 and $148 million in the first nine months. Higher volume and currency supported gross profit, but gross margin percentages contracted.
Outlook, commentary, and risks
- Management forecast Q4 FY2018 sales of $3.59–$3.69 billion and FY2018 sales of $14.58–$14.68 billion. Forecast diluted EPS from continuing operations was $1.23–$1.25 for Q4 and $3.79–$3.81 for FY2018.
- Management expected growth led by Transportation Solutions and, to a lesser extent, Industrial Solutions, partly offset by Communications Solutions declines. The outlook assumed foreign exchange rates and commodity prices remained near current levels; Q4 currency effects were expected to reduce sales by about $49 million and EPS by $0.02 versus Q4 FY2017.
- A new footprint-consolidation restructuring program generated $111 million of charges in the first nine months. Management expected approximately $130 million in total charges for these actions and approximately $90 million in annualized savings by the end of FY2020. Total FY2018 restructuring charges were forecast at approximately $150 million.
- Nine-month tax expense was $789 million, including a $567 million Tax Act charge, primarily from revaluing U.S. deferred tax assets after the federal corporate tax rate reduction. Management noted that further tax guidance could affect the treatment of interest carryforwards.
- Environmental remediation costs were estimated at a reasonably possible range of $15–$43 million; $18 million was accrued. The company reported $283 million of letters of credit, guarantees, and surety bonds. Management did not expect pending legal matters to have a material financial effect.
- Key disclosed risks include economic and end-market cycles, automotive demand, competition and pricing, raw-material availability and cost, foreign exchange, suppliers, acquisitions, business interruptions, cybersecurity, regulation, litigation, and tax-law uncertainty. Management said it was monitoring macroeconomic conditions and managing costs and capital resources.
Important facts for investors to verify
- Whether forecast FY2018 sales and EPS were achieved, and how actual results compared with the stated ranges and currency assumptions.
- Whether gross-margin pressure, price erosion, and higher material prices persisted, and whether restructuring savings materialized as expected.
- Whether subsea communications production delays resolved and Communications Solutions operating performance stabilized.
- Cash generation after elevated capital spending, share repurchases, dividends, and the December 2018 debt maturities.
- The eventual tax effects of the Tax Act, especially the treatment of interest carryforwards and the large deferred-tax revaluation charge.