TE Connectivity Ltd. — Form 10-Q Summary
Business context and reporting period
Global designer and manufacturer of connectivity and sensor solutions. This unaudited filing covers the quarter and nine months ended June 24, 2016, compared with the periods ended June 26, 2015. Fiscal 2016 is a 53-week year.
Financial performance and liquidity
| Metric | Quarter ended June 24, 2016 | Nine months ended June 24, 2016 |
|---|---|---|
| Net sales | $3.121 billion | $8.906 billion |
| Gross margin / percentage of sales | $1.022 billion / 32.7% | $2.929 billion / 32.9% |
| Operating income / margin | $452 million / 14.5% | $1.385 billion / 15.6% |
| Net income | $839 million | $1.572 billion |
| Diluted EPS | $2.32 | $4.21 |
| Continuing operating cash flow | Not provided for the quarter | $1.237 billion |
| Free cash flow (non-GAAP) | Not provided for the quarter | $991 million |
Quarterly sales were essentially flat year over year; nine-month sales declined 3.7%. Gross margin rate fell 0.9 percentage points in the quarter and 0.8 points year to date. Quarterly operating income declined $17 million, while nine-month operating income rose $43 million, including the CPD divestiture gain.
Reported earnings were materially affected by tax settlements: the quarter included a $1.019 billion income tax benefit, while other expense was $651 million. The nine-month tax benefit was $831 million and other expense was $631 million. These figures include a $1.135 billion tax benefit from resolution of disputed IRS matters and a $604 million reduction in related indemnification receivables under the Tax Sharing Agreement. Reported EPS therefore should not be viewed as a measure of underlying operating performance.
At June 24, 2016, cash was $694 million, down from $3.329 billion at fiscal year-end. Current assets were $4.929 billion and current liabilities $3.311 billion. Total debt was $4.036 billion, compared with $3.884 billion at fiscal year-end; cash less debt was approximately negative $3.342 billion. The company had a $1.5 billion revolving facility with no borrowings and $300 million of commercial paper outstanding. It reported compliance with debt covenants.
Material changes versus comparable periods
- Quarterly organic sales declined 0.6%; nine-month organic sales declined 1.3%. Foreign exchange reduced nine-month sales by $265 million; price erosion was $44 million for the quarter and $147 million year to date.
- Transportation Solutions sales increased 1.9% in the quarter, led by automotive, but segment operating margin declined to 18.0% from 18.7%. Nine-month sales fell 1.6%, largely due to currency translation.
- Industrial Solutions sales rose 5.3% in the quarter, including acquisition contributions, despite a 3.6% organic decline. Nine-month sales fell 3.8%; operating margin declined to 9.8% from 11.2%.
- Communications Solutions sales fell 10.3% in the quarter and 8.7% year to date. Data and Devices weakened, while Subsea Communications grew. The nine-month segment operating result benefited from the $143 million CPD sale gain.
- Gross margin was pressured by unfavorable product mix and price erosion; lower material costs partly offset the pressure. SG&A declined, reflecting cost controls and restructuring savings.
- Operating cash flow from continuing operations increased to $1.237 billion from $1.079 billion; management attributed the improvement principally to working-capital changes. The company repurchased $2.514 billion of shares in the nine-month period, compared with $536 million in the prior-year period.
Outlook, commentary, and risks
- Fiscal 2016 guidance: sales of $12.15–$12.35 billion and diluted EPS of $5.13–$5.19. Fourth-quarter guidance: sales of $3.25–$3.45 billion and diluted EPS of $1.10–$1.16. Fourth-quarter guidance includes an additional week, estimated to add about $200 million in sales and $0.10 per share. The company said currency would reduce fiscal-year sales by about $254 million and EPS by $0.07 versus fiscal 2015.
- Management expected automotive growth to support Transportation Solutions; Creganna and aerospace demand to support Industrial Solutions; and data-and-devices weakness, CPD divestiture, and product-line exits to weigh on Communications Solutions. It cited oil-and-gas weakness and monitored macroeconomic conditions, including the proposed UK exit from the EU.
- A fiscal 2016 restructuring program includes workforce reductions and Communications Solutions product-line closures. The company expects approximately $124 million in total charges, with $87 million incurred through June 24, and approximately $100 million in annualized savings by the end of fiscal 2017.
- Three businesses, including Creganna, were acquired for $994 million net of cash acquired. A further acquisition of Intercontec for approximately $340 million was pending customary closing conditions and regulatory approvals.
- The Com-Net dispute was settled in July 2016 for $96 million, paid after quarter-end; a $30 million reserve release was recorded in the quarter. Environmental remediation costs were estimated at $16–$43 million, with $19 million as the best estimate. Outstanding letters of credit, guarantees, and surety and appeal bonds totaled $490 million.
- Risks discussed include economic and industry cyclicality, customer demand, pricing pressure, raw-material costs, foreign exchange, acquisitions and divestitures, litigation, tax matters, suppliers, cybersecurity, and regulatory requirements. Management stated that operating cash flow and other funding sources should meet anticipated capital needs for the foreseeable future.
Most important facts for investors to verify
- Separate recurring operating results from the unusually large IRS-related tax benefit and associated other expense when assessing earnings and EPS.
- Track organic sales, pricing, and margins by segment, particularly industrial-equipment and data-and-devices demand and the automotive outlook.
- Assess cash conversion and liquidity after substantial share repurchases, acquisitions, and tax-related payments; confirm the timing and cash impact of remaining restructuring costs.
- Monitor acquisition integration and final purchase-price allocations for fiscal 2016 acquisitions, as well as the closing and terms of the pending Intercontec transaction.
- Review the post-quarter Com-Net settlement payment, continuing tax-sharing obligations, and disclosed legal and environmental contingencies.