TE Connectivity Ltd. — Form 10-Q Summary
Reporting period: First quarter of fiscal 2014, ended December 27, 2013; comparison is the quarter ended December 28, 2012. The filing identifies the registrant as TE Connectivity Ltd. (not Plc). Unless indicated otherwise, amounts are in U.S. dollars.
Business and operating context
TE Connectivity designs and manufactures connectivity products for automotive, industrial, communications, consumer, healthcare, and aerospace and defense markets. It reports four segments: Transportation Solutions, Industrial Solutions, Network Solutions, and Consumer Solutions. The Relay Products business moved from Consumer to Industrial Solutions this quarter; prior-period segment results were restated.
Financial results
| Metric | Q1 FY2014 | Q1 FY2013 |
|---|---|---|
| Net sales | $3,326 million | $3,134 million |
| Gross margin | $1,117 million; 33.6% of sales | $989 million; 31.6% of sales |
| Operating income | $479 million | $293 million |
| Income from continuing operations | $355 million | $279 million |
| Net income attributable to TE Connectivity | $353 million | $277 million |
| Diluted EPS | $0.84 net income; $0.85 continuing operations | $0.65 |
| Operating cash flow | $385 million | $392 million |
| Free cash flow (non-GAAP) | $266 million | $304 million |
| Capital expenditures | $133 million | $126 million |
Reported sales increased 6.1%; organic sales increased 7.2%. Higher volume and manufacturing productivity lifted gross margin, partly offset by price erosion. Operating income also benefited from substantially lower restructuring charges ($7 million versus $92 million). SG&A rose to $467 million from $428 million, mainly on higher selling and incentive compensation costs.
Segment sales and operating income: Transportation Solutions, $1,440 million and $296 million; Industrial Solutions, $763 million and $99 million; Network Solutions, $713 million and $46 million; Consumer Solutions, $410 million and $38 million. Transportation sales grew 13.9% organically, led by automotive. Industrial sales grew 6.2% organically. Network sales declined 2.9% reported, with flat organic sales; Consumer sales declined 1.4% reported, despite 0.7% organic growth. Network operating income improved year over year, but excluding restructuring charges it declined, reflecting price erosion and higher material costs.
Balance sheet, debt, and liquidity
- At December 27, 2013, cash and cash equivalents were $1,397 million; total current assets were $6,358 million and current liabilities were $3,409 million.
- Total debt was $2,998 million, compared with $3,014 million at September 27, 2013. Current maturities were $383 million and long-term debt was $2,615 million.
- The company redeemed $300 million of 5.95% notes due 2014 and issued $325 million of 2.375% notes due 2018. Commercial paper outstanding was $325 million. A $1.5 billion revolving credit facility had no borrowings; the company reported compliance with debt covenants.
- Operating cash flow was nearly flat year over year; free cash flow fell to $266 million from $304 million, mainly due to increased inventory and restructuring- and incentive-related cash use. Cash decreased by $6 million during the quarter.
- Shareholder distributions included $103 million of dividends and distributions and $210 million of share repurchases. The board increased the repurchase authorization by $1 billion; $1,267 million remained available at quarter-end.
Outlook, risks, and unusual items
- Guidance: Q2 FY2014 sales of $3.4–$3.5 billion and diluted EPS of $0.86–$0.90. Fiscal 2014 sales guidance was $13.8–$14.2 billion and diluted EPS guidance was $3.60–$3.80. Management expected Transportation and Industrial growth, while Network and Consumer sales were expected to be broadly in line with fiscal 2013. Outlook assumed foreign exchange rates and commodity prices near current levels.
- Restructuring: Management expected approximately $50 million of restructuring charges and $175 million of cash spending in fiscal 2014, with approximately $115 million in annualized savings expected by the end of fiscal 2015.
- Tax matters: The prior-year quarter included a $331 million tax benefit related to settlement of undisputed pre-separation tax matters and $231 million of related other expense. The current quarter included a $127 million tax provision and $32 million of other income, including an $18 million share of a settlement under the Tax Sharing Agreement. These items make year-over-year earnings comparisons less representative of underlying operations.
- Contingency: The IRS dispute concerning historical intercompany debt deductions remains unresolved and is being contested in U.S. Tax Court. The IRS notices asserted taxes, penalties, and withholding taxes, with additional interest potentially applicable. TE Connectivity bears a 31% share under the tax-sharing arrangement and warns that an adverse outcome could materially affect results, financial position, or cash flows. Management stated it believed its reserves were appropriate and expected approximately $200 million of net cash payments for pre-separation tax matters over the next 12 months.
- Other disclosed exposures include ordinary-course litigation, an $80 million disputed contingent purchase-price claim for which no liability was recorded, and estimated environmental remediation costs of $13 million (within a probable range of $12–$24 million). Management did not expect these other matters to have a material adverse effect.
- Principal business risks include economic and end-market cyclicality, automotive demand, pricing pressure, raw-material costs and availability, foreign exchange, suppliers, litigation, regulation, and debt limitations. The filing reported no material changes to previously disclosed risk factors and no significant change in market-risk exposures.
Important facts for investors to verify
- Whether revenue growth and margin improvement persist, particularly in automotive, and whether price erosion remains manageable.
- How much of reported earnings improvement reflects lower restructuring charges and the unusual prior-year tax and other-expense items.
- Progress against fiscal 2014 sales and EPS guidance, and delivery and timing of the expected restructuring savings.
- Inventory trends, free cash flow generation, and the planned $200 million of pre-separation tax-related cash payments.
- Developments in the IRS tax litigation, potential exposure under the 31% sharing obligation, and adequacy of recorded tax reserves.
- Capital allocation choices, including share repurchases, dividends, debt refinancing, and remaining revolver availability.