Business context and reporting period
TE Connectivity Ltd. filed this unaudited Form 10-Q for the quarter and nine months ended June 29, 2012, compared with periods ended June 24, 2011. The company designs and manufactures products for connecting and protecting power and data across consumer and industrial markets. Its reportable segments are Transportation Solutions, Communications and Industrial Solutions, and Network Solutions. Unless stated otherwise, amounts are U.S. dollars.
Financial performance and liquidity
| Metric | Quarter ended June 29, 2012 | Prior-year quarter | Nine months ended June 29, 2012 | Prior-year nine months |
|---|---|---|---|---|
| Net sales | $3.499 billion | $3.579 billion | $9.918 billion | $10.025 billion |
| Gross margin | $1.018 billion; 29.1% | $1.088 billion; 30.4% | $2.982 billion; 30.1% | $3.087 billion; 30.8% |
| Operating income | $371 million; 10.6% of sales | $460 million; 12.9% | $1.117 billion; 11.3% | $1.242 billion; 12.4% |
| Income from continuing operations | $260 million | $351 million | $768 million | $907 million |
| Net income attributable to TE Connectivity | $199 million | $355 million | $716 million | $919 million |
| Diluted EPS | $0.46 | $0.80 | $1.67 | $2.06 |
For the quarter, reported sales fell 2.2% and organic sales fell 3.1%; for the nine months, reported sales declined 1.1% and organic sales declined 2.5%. Foreign exchange reduced sales by $143 million for the quarter and $184 million for the nine months. Acquisition contributions partly offset those effects.
- Cash flow: Nine-month cash from continuing operating activities was $1.174 billion, versus $1.114 billion a year earlier. Company-reported free cash flow, a non-GAAP measure with adjustments detailed in the filing, was $865 million versus $802 million. Capital expenditures were $385 million.
- Cash and liquidity: Cash and equivalents were $1.302 billion at June 29, 2012, up from $1.218 billion at September 30, 2011. Current assets were $6.432 billion and current liabilities $4.070 billion. The company had no borrowings under its $1.5 billion revolving credit facility.
- Debt: Total debt was $3.759 billion, including $1.066 billion classified as current, compared with $2.667 billion at September 30, 2011. The company issued $750 million of senior notes in February and had $350 million of commercial paper outstanding. It reported compliance with debt covenants; its revolving facility includes a maximum debt-to-EBITDA covenant of 3.5 to 1.0.
- Shareholder distributions: Cash dividends and distributions were $243 million in the first nine months. No shares were repurchased under the public repurchase authorization in that period.
Material changes versus the prior comparable period
- Transportation Solutions sales rose 12.7% in the quarter and 9.2% year to date, including Deutsch acquisition sales. Nine-month segment operating income increased to $633 million from $611 million, while quarterly income fell to $183 million from $211 million, partly reflecting acquisition-related charges.
- Communications and Industrial Solutions sales fell 11.7% in the quarter and 12.8% for the nine months. Nine-month operating income declined to $232 million from $426 million, amid weakness in industrial, data communications, consumer devices, and appliance markets.
- Network Solutions sales declined 12.6% in the quarter and 1.7% for the nine months. Nine-month operating income rose to $252 million from $205 million, helped by lower prior-year acquisition-related and restructuring charges; quarterly income declined to $92 million from $129 million.
- Deutsch was acquired April 3, 2012 for a stated transaction value of approximately $2.05 billion, net of cash acquired. It contributed $174 million in quarterly sales and a $62 million operating loss, including substantial acquisition-accounting amortization, acquisition, restructuring, and integration costs. The purchase-price allocation remained preliminary.
- Touch Solutions was sold June 1 for net proceeds of $380 million, subject to working-capital adjustments; TE Professional Services was sold April 27 for $29 million. The Touch Solutions sale produced an insignificant pretax loss but a $65 million tax charge. Together, discontinued operations generated a $61 million quarterly loss, compared with $6 million of income in the prior-year quarter.
Outlook, management commentary, risks and unusual items
- Guidance: Management forecast fourth-quarter fiscal 2012 sales of $3.325–$3.425 billion and diluted EPS of $0.64–$0.68. Fiscal 2012 sales guidance was $13.25–$13.35 billion and diluted EPS guidance $2.41–$2.45. The outlook assumed then-current foreign-exchange and commodity rates. Deutsch sales were expected to be about $180 million in Q4 and $360 million for fiscal 2012.
- Demand and markets: Management cited weakness in industrial and data communications markets, lower telecom-carrier spending, and reduced subsea project activity. It expected continued weakness in industrial, data communications, and appliance markets and lower telecom-network spending in Q4. Automotive growth and Deutsch were expected to support Transportation Solutions.
- Costs and restructuring: Manufacturing simplification generated about $80 million of charges in the first nine months; management expected about $110 million of charges and $150 million of cash spending for fiscal 2012, with approximately $85 million of annualized savings. Deutsch-related restructuring was expected to generate about $9 million of annualized savings in fiscal 2013.
- Tax uncertainty: The balance sheet included $1.303 billion of accrued interest and penalties for uncertain tax positions and a $239 million liability under the Tyco/Covidien tax-sharing arrangements. Disputed IRS matters include proposed adjustments of approximately $1 billion for 1997–2000; management warned that ultimate resolution could materially affect results, financial position, or cash flows. Up to approximately $200 million of unrecognized tax benefits, excluding interest and penalties, could be resolved within twelve months.
- Other exposures: The filing describes ongoing legal proceedings, environmental remediation reserves of $13 million (within an estimated $13–$26 million range), $349 million of letters of credit and guarantees, and an $80 million maximum contingent purchase-price claim related to Com-Net, for which no liability was recorded. The company reported that identified ordinary-course legal matters were not expected to have a material effect. A compliance review had found that some historical practices may not have complied with FCPA requirements; recorded amounts were described as not significant.
- Other unusual items: The quarter included $68 million of Deutsch acquisition-accounting charges, alongside acquisition and integration costs and restructuring. The filing said the Deutsch purchase-price allocation could still change significantly. Management said cash from operations and potential funding sources should meet anticipated capital needs, including payment of the 6.00% notes due October 2012.
Important facts for investors to verify
- Whether fourth-quarter and full-year sales and diluted-EPS guidance was achieved, and how much results depended on currency, end-market demand, and Deutsch.
- Underlying segment profitability after separating acquisition-accounting charges, restructuring, and integration costs from reported results.
- Deutsch’s final purchase-price allocation, integration progress, realized synergies, and contribution to operating cash flow.
- Resolution, timing, and cash consequences of IRS examinations and tax-sharing obligations, including the significant accrued tax interest and penalties.
- Debt repayment and refinancing following the October 2012 note maturity, and the company’s liquidity and covenant headroom.
- Whether the anticipated manufacturing-simplification savings and restructuring cash costs were realized as forecast.