TE Connectivity Ltd. — Form 10-Q Summary
Reporting period: Quarter ended March 25, 2011 (fiscal second quarter), with six-month comparisons to March 26, 2010. The company changed its name from Tyco Electronics Ltd. effective March 10, 2011; its NYSE ticker remained TEL. All amounts are U.S. dollars.
Business context
TE Connectivity designs and manufactures products connecting and protecting power and data across consumer and industrial markets. It reported three segments: Transportation Solutions, Communications and Industrial Solutions, and Network Solutions. Fiscal 2011 segment results reflect a reorganization; prior-period segment data was reclassified. ADC Telecommunications, acquired in December 2010, is included in Network Solutions.
Key financial results
| Metric | Quarter | Six months |
|---|---|---|
| Net sales | $3.472bn, up 17.4%; organic growth 7.4% | $6.672bn, up 14.1%; organic growth 9.4% |
| Gross margin | $1.044bn; 30.1%, versus 32.4% | $2.065bn; 31.0%, versus 30.8% |
| Operating income | $405m, versus $398m; margin 11.7%, versus 13.5% | $805m, versus $667m; margin 12.1%, versus 11.4% |
| Net income attributable to TE Connectivity | $299m, versus $304m; diluted EPS $0.67, versus $0.66 | $564m, versus $476m; diluted EPS $1.26, versus $1.03 |
| Cash from operating activities | $557m, versus $500m | $711m, versus $830m |
| Capital expenditures | $114m, versus $81m | $231m, versus $157m |
Quarterly gross-margin compression reflected price erosion, higher material costs, and acquisition-accounting charges, partly offset by volume and manufacturing productivity. Six-month operating-income improvement included higher sales and restructuring savings. ADC added $279m of quarterly sales but reported a $31m operating loss, including $30m of acquisition-accounting amortization and $17m of restructuring charges.
By segment, quarterly sales and operating income were: Transportation Solutions $1.357bn and $211m; Communications and Industrial Solutions $1.208bn and $146m; Network Solutions $907m and $48m. Transportation results benefited from automotive recovery; Communications and Industrial operating income fell year over year; Network Solutions’ reported profit was weighed down by ADC-related charges and weaker subsea communications activity.
Financial position, liquidity and capital allocation
- Cash was $1.239bn at March 25, down from $1.990bn at fiscal year-end. Total debt was $2.744bn, up from $2.413bn; net debt therefore increased to approximately $1.505bn from $423m.
- Current assets were $6.743bn and current liabilities $3.750bn. The company reported no borrowings under its $1.425bn effective revolving credit commitment and stated it was in compliance with debt covenants, including a maximum 3.5-to-1 debt-to-EBITDA covenant.
- Six-month cash flow used $790m in investing activities, including the $717m net-cash ADC acquisition, and $684m in financing activities. Cash declined $751m. Operating cash flow was below the prior year, primarily due to inventory growth and lower accrued liabilities; inventory rose to $1.912bn from $1.583bn.
- Capital expenditures were expected to be approximately 4% of fiscal 2011 sales. The company repurchased $281m of shares in the first six months and paid $141m in distributions. Shareholders approved future quarterly dividends of $0.18 per share for the third quarter of fiscal 2011 through the second quarter of fiscal 2012.
Outlook, management commentary and material risks
- Management forecast fiscal 2011 sales of $14.0–$14.3bn, growth of 16%–18%, and diluted continuing-operations EPS of $2.73–$2.85. Third-quarter guidance was sales of $3.50–$3.65bn and EPS of $0.65–$0.71; fourth-quarter sales of $3.83–$3.98bn and EPS of $0.82–$0.88. Fiscal 2011 includes an additional week; management attributed about $0.05 of EPS to that week. Guidance assumed then-current foreign exchange and commodity rates.
- Following the Japan earthquake and tsunami, the company estimated second-quarter sales and diluted EPS impacts of $20m and $0.01. It expected impacts of approximately $135m and $0.09 per share in the third quarter, and $220m and $0.14 per share for the full year. Facilities were not materially damaged, but customer and supply-chain disruptions were reported.
- ADC integration restructuring was expected to total approximately $80m through fiscal 2012, with about $100m of annualized savings; roughly 40% of savings was expected in fiscal 2011. Manufacturing simplification was expected to produce approximately $25m in annualized savings.
- Management cited global economic and end-market demand, pricing pressure, raw-material costs, currency movements, suppliers, acquisition integration and synergy delivery, and natural disasters among key risks. Copper and gold prices were materially higher than the prior-year quarter.
- Contingencies include unresolved pre-separation tax matters and $1.323bn of accrued interest and penalties related to uncertain tax positions. The company warned that ultimate tax resolution could materially affect results, financial position, or cash flows. It also faced a New York State contract dispute: the State alleged damages exceeding $275m, had drawn $50m under a letter of credit, and could draw up to another $50m; trial was scheduled for October 2011. An $80m Com-Net contingent purchase-price claim was not accrued because payment was not considered probable or estimable.
- Other unusual items include the prior-year $75m quarterly other-income contribution, primarily a tax-sharing adjustment, compared with $6m this quarter; and $52m of six-month restructuring and other charges. Management stated disclosure controls were effective; assessment of ADC’s internal controls was not yet complete.
Most important facts for investors to verify
- Whether sales growth and margins hold up after separating organic performance from ADC’s contribution and acquisition-related charges.
- ADC’s operating performance, integration progress, restructuring spending, and realization of the stated savings.
- Cash conversion, working-capital trends, capital spending, and debt/net-debt changes after the acquisition and shareholder distributions.
- Actual effects of Japan-related disruption versus the forecast, and the assumptions behind full-year guidance.
- Developments in the New York State litigation and pre-separation tax matters, including potential cash exposure and allocation under the tax-sharing arrangements.