Business context and reporting period
TE Connectivity Ltd. filed this unaudited Form 10-Q for the first quarter of fiscal 2013, ended December 28, 2012, comparing results with the quarter ended December 30, 2011. The company designs and manufactures connectivity products for automotive, industrial, communications, consumer, energy, aerospace and other markets. It reorganized reporting into four segments: Transportation Solutions, Network Solutions, Industrial Solutions and Consumer Solutions; prior-period segment results were restated.
Financial performance
| Metric | Q1 FY2013 | Q1 FY2012 |
|---|---|---|
| Net sales | $3.134 billion | $3.170 billion |
| Gross margin | $989 million; 31.6% | $943 million; 29.7% |
| Operating income | $293 million; 9.3% of sales | $361 million; 11.4% of sales |
| Income from continuing operations | $279 million | $240 million |
| Net income attributable to TE Connectivity | $277 million | $260 million |
| Diluted EPS | $0.65 | $0.61 |
| Cash provided by operating activities | $392 million total; $393 million continuing | $207 million total; $195 million continuing |
| Free cash flow (company-defined non-GAAP) | $304 million | $79 million |
Reported sales declined 1.1%; organic sales declined 4.4%, with $148 million of sales from the Deutsch acquisition partly offsetting organic weakness and $43 million of adverse currency translation. Gross margin improved on manufacturing productivity, partly offset by price erosion and mix. SG&A rose to $428 million from $383 million; R&D was $171 million versus $177 million. Restructuring and other charges increased to $92 million from $18 million.
Segment results: Transportation Solutions sales were $1.264 billion and operating income $192 million; Network Solutions, $734 million and $36 million; Industrial Solutions, $700 million and $70 million; Consumer Solutions, $436 million and an operating loss of $5 million. Network sales fell 8.5% and Consumer sales fell 3.5%; reported Industrial sales grew 2.2% largely with Deutsch, despite an 8.0% organic decline. Transportation sales grew 2.7% reported, while organic sales declined 1.0%.
Balance sheet, cash flow and capital
At December 28, 2012, cash was $972 million, down from $1.589 billion at fiscal year-end. Total debt was $3.038 billion, down from $3.711 billion, including repayment of $714 million of senior notes; long-term debt was $2.687 billion. Current assets were $5.753 billion and current liabilities $3.111 billion. Total liabilities were $10.002 billion and equity $8.134 billion. A $1.5 billion revolving credit facility, expiring June 2016, had no borrowings; the company reported compliance with debt covenants.
Operating cash flow improved, primarily from working capital, partly offset by higher taxes paid. Capital expenditures were $126 million. Investing activities used $105 million; financing activities used $905 million, including debt repayment, $167 million of share repurchases and $89 million of shareholder distributions. The company reported $2.576 billion of backlog, versus $2.633 billion at September 28, 2012.
Material changes, outlook and commentary
- Management attributed organic sales weakness mainly to industrial and subsea communications markets, alongside softness in telecom, data communications and enterprise networks. Deutsch contributed $148 million of quarterly sales.
- For Q2 FY2013, management expected sales of $3.2–$3.3 billion and diluted EPS of $0.50–$0.54. It expected weakness in Network and Consumer Solutions, industrial and communications end markets, and lower subsea project activity; Deutsch sales were expected to be about $175 million. Global automotive production was forecast to decline about 4% year over year.
- For FY2013, management expected sales of $13.3–$13.7 billion and diluted EPS of $2.79–$2.99, with global automotive production slightly above FY2012. Outlook assumptions used foreign exchange rates and commodity prices consistent with then-current levels.
- The company planned manufacturing-footprint and headcount restructuring. Management’s MD&A forecast approximately $225 million of net restructuring charges and $180 million of cash spending in FY2013, with about $85 million in annualized savings expected by the end of FY2015. A separate note estimates approximately $139 million of total charges for fiscal-2013 actions; the figures appear to cover different scopes and should be reconciled.
- The board recommended a 19% quarterly distribution increase, from $0.21 to $0.25 per share, for the four quarters beginning Q3 FY2013, subject to shareholder approval. The company repurchased about 5.0 million shares under its authorization during the quarter.
Unusual items, risks and contingencies
- Net income was materially affected by a tax-related settlement: the company recorded a $331 million income tax benefit and $226 million of other expense under its Tax Sharing Agreement. The filing also describes $231 million of other expense in connection with the settlement; the amounts are presented in different disclosures and merit reconciliation. The quarter’s tax benefit does not represent ordinary operating performance.
- One IRS dispute remains over the tax treatment of historical intercompany debt transactions. TE Connectivity said it believed its reserve was adequate, but an adverse outcome could materially affect results, financial position or cash flows. Its share of the matter is governed by the tax-sharing arrangements with Tyco International and Covidien. The recorded tax-sharing indemnification liability was $241 million.
- Environmental remediation costs were estimated at $13–$24 million, with a best estimate of $14 million accrued. A disputed contingent purchase-price claim related to Com-Net has a maximum stated amount of $80 million; no liability was recorded because payment was not considered probable or reasonably estimable. Letters of credit and guarantees totaled $343 million.
- Key operating risks include global economic and end-market weakness, pricing pressure, raw-material costs and availability, foreign exchange, customer and supplier conditions, acquisition integration and the ability to deliver restructuring savings. Management said market-risk exposures had no significant change and reported effective disclosure controls.
Important facts for investors to verify
- Reconcile the tax settlement disclosures, including the $331 million tax benefit and differing reported amounts of related other expense, and assess remaining IRS exposure.
- Confirm the scope and expected timing of restructuring costs: $92 million reported for the quarter, $139 million estimated for fiscal-2013 actions, and $225 million of FY2013 net charges forecast in MD&A; evaluate the $85 million savings target.
- Assess whether organic sales declines and segment margin pressure persist, particularly in Network Solutions, Industrial Solutions and Consumer Solutions, and distinguish acquisition-supported reported growth from underlying trends.
- Monitor cash conversion, cash decline, debt maturities and repayments, and whether the proposed distribution increase and ongoing repurchases remain supported by operating cash flow.
- Track performance against Q2 and FY2013 sales and EPS guidance, including the stated market, automotive production, currency and commodity assumptions.