TE Connectivity Ltd. — Form 10-Q Summary
Reporting period: Third quarter of fiscal 2014, ended June 27, 2014; comparisons are with the quarter and nine months ended June 28, 2013. All financial amounts are in U.S. dollars. TE Connectivity designs and manufactures connectivity products across transportation, industrial, network, and consumer markets.
Financial performance
| Metric | Q3 FY2014 | Q3 FY2013 | Nine months FY2014 | Nine months FY2013 |
|---|---|---|---|---|
| Net sales | $3.580 billion | $3.449 billion | $10.337 billion | $9.848 billion |
| Gross margin | $1.204 billion; 33.6% | $1.132 billion; 32.8% | $3.494 billion; 33.8% | $3.173 billion; 32.2% |
| Operating income | $535 million | $439 million | $1.524 billion | $1.091 billion |
| Net income | $403 million | $335 million | $1.118 billion | $889 million |
| Diluted EPS | $0.97 | $0.80 | $2.68 | $2.10 |
- Quarterly reported sales rose 3.8% and organic sales rose 2.6%; nine-month reported sales rose 5.0% and organic sales rose 5.2%. Price erosion reduced organic sales by $70 million in the quarter and $193 million over nine months.
- Operating margin was approximately 14.9% for Q3 versus 12.7% a year earlier, and approximately 14.7% for nine months versus 11.1%. Improved productivity and volume supported margins; price erosion was a partial offset.
- Q3 sales growth was led by Transportation Solutions (+10.2% reported; +8.3% organic) and Industrial Solutions (+5.7%; +4.3%). Network Solutions declined 8.1% reported and 8.3% organic. Consumer Solutions was approximately flat.
- Nine-month operating cash flow was $1.334 billion, down from $1.453 billion. Capital expenditures were $476 million versus $412 million. Management-reported free cash flow, a non-GAAP measure, was $1.069 billion versus $1.088 billion; its calculation adjusts for net pre-separation tax payments.
- Cash and equivalents were $1.613 billion at quarter end, compared with $1.403 billion at September 27, 2013. Current assets were $6.873 billion and current liabilities $3.860 billion (current ratio approximately 1.78).
- Total debt was $3.000 billion, versus $3.014 billion at fiscal year-end; cash exceeded total debt by approximately $1.387 billion. The company had $625 million of current maturities and $2.375 billion of long-term debt. It reported compliance with debt covenants.
Material changes and unusual items
- Quarterly operating income benefited from lower restructuring charges: $14 million versus $67 million. Nine-month charges were $42 million versus $240 million. FY2014 restructuring actions are expected to cost approximately $65 million for the year and deliver about $30 million in annualized savings by the end of FY2016; FY2013 actions are expected to deliver about $115 million in annualized savings by the end of FY2015.
- Nine-month tax and other items make the year-over-year earnings comparison less straightforward. FY2014 included a $376 million tax provision and $57 million of other income; FY2013 included a $92 million tax benefit and $199 million of other expense. The prior-year period included a $331 million tax benefit and $231 million other expense related to settlement of undisputed pre-separation tax matters.
- The company repurchased approximately 8 million shares for $441 million during the first nine months, paid $324 million in dividends and distributions, and had $1.038 billion remaining under its repurchase authorization.
- On June 30, 2014, after quarter-end, the company acquired SEACON for $452 million in cash. It had also agreed to acquire Measurement Specialties for $86 per share in cash, with an approximate total transaction value of $1.7 billion including assumed debt. The proposed deal was expected to close in calendar 2014, subject to shareholder, regulatory, and other customary approvals.
Outlook, risks, and contingencies
- FY2014 guidance was net sales of $13.9–$14.0 billion and diluted EPS of $3.62–$3.66. Q4 guidance was sales of $3.56–$3.66 billion and diluted EPS of $0.93–$0.97. Guidance assumed current foreign-exchange rates and commodity prices and excluded Measurement Specialties.
- Management expected FY2014 Transportation Solutions sales growth of approximately 11%, Industrial Solutions growth, modest Network Solutions decline, and a slight Consumer Solutions decline. Network weakness was concentrated in subsea and data communications; expected subsea sales were approximately $285 million for FY2014.
- Management cited exposure to global economic and end-market conditions, automotive demand, competition and pricing pressure, commodity costs, foreign exchange, suppliers, acquisitions, regulation, litigation, and debt-covenant limits. Approximately 55% of sales were invoiced in currencies other than the U.S. dollar.
- A disputed IRS matter involving pre-separation intercompany debt could have a material adverse effect if resolved against the company. The IRS notices asserted taxes of $778 million, penalties of $154 million, and withholding taxes of $105 million, plus potential additional amounts; TE Connectivity bears a 31% share under its tax-sharing arrangement. The company stated it believed its reserves were appropriate. It expected approximately $32 million in net cash payments for pre-separation tax matters over the next 12 months.
- Other disclosed matters include an $80 million maximum disputed contingent purchase price from the Com-Net acquisition, not accrued because management did not consider payment probable; environmental remediation estimates of $15–$33 million, with $17 million accrued; and $316 million of outstanding letters of credit and guarantees. Management did not expect ordinary-course legal matters to have a material effect, but the tax proceedings could be material.
- Measurement Specialties shareholders filed putative class actions seeking to enjoin the transaction or obtain unspecified damages; TE Connectivity said it intended to defend the claims. The filing reported no material changes to previously disclosed risk factors other than acquisition-related risks.
Investor verification priorities
- Track the Measurement Specialties approval, litigation, financing, closing, and integration risks; confirm how the approximately $1.3 billion of anticipated funding beyond company cash is sourced.
- Monitor the IRS dispute, tax-sharing allocation, reserve adequacy, audit developments, and actual cash payments.
- Assess whether Network Solutions’ subsea and data-communications declines stabilize, and whether Transportation and Industrial growth offsets weakness.
- Reconcile reported operating cash flow with management’s free-cash-flow measure, including its treatment of tax payments, and monitor working capital and capital spending.
- Test whether restructuring costs and projected savings are realized, and review acquisition-related costs and effects on debt and liquidity.