TE Connectivity Ltd. — Q1 Fiscal 2019 Form 10-Q
Reporting period: Quarter ended December 28, 2018; comparisons are with the quarter ended December 29, 2017. Amounts are in U.S. dollars unless noted.
Business context and results
TE Connectivity designs and manufactures connectivity and sensor products across transportation, industrial, communications, and other markets. Reported net sales were nearly flat, as organic growth and acquisition contributions were largely offset by foreign-currency translation.
- Revenue: $3.347 billion, up 0.3%; organic sales growth was 1.9%. Currency translation reduced sales by $73 million, while acquisitions added $21 million. Price erosion reduced organic sales by $28 million.
- Segment sales: Transportation Solutions $1.986 billion, down 2.3%; Industrial Solutions $928 million, up 5.2%; Communications Solutions $433 million, up 2.6%.
- Profitability: Gross margin was $1.114 billion (33.3% of sales), versus $1.164 billion (34.9%). Operating income was $484 million, down $102 million; operating margin fell to 14.5% from 17.6%.
- Earnings: Continuing-operations income was $383 million, compared with a $33 million loss. Net income was $276 million, versus a $40 million loss; diluted EPS was $0.80, versus a $0.11 loss. The quarter included a $107 million after-tax loss from discontinued operations.
- Cash flow: Continuing operating cash flow was $328 million, up from $283 million; capital expenditures were $210 million. Total operating cash flow was $297 million, including discontinued operations. Cash ended at $505 million, down $343 million from the fiscal-year start.
- Liquidity and debt: Current assets were $5.378 billion and current liabilities $3.471 billion. Short- and long-term debt totaled $3.967 billion, compared with $4.000 billion at September 28, 2018. Cash less reported debt was approximately negative $3.462 billion. The company reported no borrowings under its $1.5 billion revolving credit facility and compliance with debt covenants.
- Capital returns: The company repurchased approximately 6.4 million shares for $495 million and paid $150 million in dividends. It authorized a further $1.5 billion in repurchases; $2.0 billion remained available at quarter-end.
Material changes and unusual items
- Operating income declined in all three segments: Transportation Solutions $332 million (from $417 million), Industrial Solutions $100 million (from $102 million), and Communications Solutions $52 million (from $67 million). Management cited price erosion, currency effects, and lower manufacturing productivity as factors in the overall gross-margin decline.
- The prior-year quarter’s $599 million tax expense included a $567 million charge related to the U.S. Tax Cuts and Jobs Act and a $61 million tax benefit from legal-entity restructurings. Current-quarter tax expense was $78 million; the sharp year-over-year earnings comparison is therefore affected by the prior-period tax charge.
- TE Connectivity sold its Subsea Communications (SubCom) business for $288 million net cash proceeds and recorded a $96 million pretax sale loss, primarily reflecting cumulative currency-translation losses. The sale transaction remains subject to a final working-capital adjustment.
- Adoption of ASU 2016-16 reduced opening accumulated earnings by $443 million as a cumulative accounting adjustment. Adoption of ASC 606 had no material reported transition impact.
Outlook, commentary, and risks
- Q2 FY2019 guidance: Net sales of $3.3–$3.4 billion versus $3.6 billion in the prior-year quarter; diluted EPS from continuing operations of $1.13–$1.17. Management expected automotive weakness, including approximately 9% lower global automotive production, and weakness in Asia-Pacific communications markets. Currency was expected to reduce sales by about $155 million and EPS by $0.05 year over year.
- FY2019 guidance: Net sales of $13.45–$13.85 billion versus $14.0 billion in FY2018; diluted EPS from continuing operations of $4.94–$5.14. Management expected global automotive production to decline 4–5%. Currency was expected to reduce sales by about $375 million and EPS by $0.16 year over year. Guidance assumes currency rates and commodity prices remain near current levels.
- The company initiated restructuring actions across all segments. Q1 restructuring charges were $75 million, including $67 million for the new program. Management expected about $60 million of annualized savings by the end of FY2020, approximately $160 million of FY2019 total spending, and additional charges of about $10 million for the new actions; it also said cost initiatives could be broadened or accelerated.
- SubCom-related guarantees are a significant contingent exposure: TE agreed to honor approximately $1.7 billion of existing project guarantees and letters of credit, mostly expected to expire within two years, and may issue up to $300 million of new guarantees for up to three years. A $70 million new-project guarantee was issued during the quarter. The company has contractual recourse against the buyer and does not anticipate having to perform.
- Other disclosed risks include global economic and end-market weakness, automotive demand, pricing and competition, raw-material costs and availability, foreign exchange, suppliers, cybersecurity, litigation, regulation, and debt-covenant limitations. Environmental remediation costs were estimated at a reasonably possible $15–$44 million, with $17 million accrued. Management said routine legal proceedings were not expected to have a material effect.
Key investor verification points
- Assess the causes and potential persistence of weaker gross and operating margins, especially manufacturing productivity, price erosion, and currency impacts.
- Compare subsequent results with Q2 and FY2019 sales and EPS guidance, including the automotive and Asia-Pacific assumptions.
- Track restructuring cash spending, execution, and delivery of the expected savings.
- Monitor SubCom guarantee exposure, expirations, new guarantees, and the final working-capital adjustment from the sale.
- Review cash generation against capital spending, dividends, share repurchases, debt maturities, and remaining repurchase authorization.