TE Connectivity Ltd. — Form 10-Q Summary
Reporting period: Fiscal third quarter ended June 24, 2011; comparisons are with the quarter ended June 25, 2010. Nine-month results cover the periods ended on those dates. Unless noted, amounts are U.S. dollars.
Business context
TE Connectivity designs and manufactures products that connect and protect power and data flows. It reports three segments: Transportation Solutions; Communications and Industrial Solutions; and Network Solutions. The company acquired ADC Telecommunications in December 2010 and reports ADC in Network Solutions. Fiscal 2011 segment structure was reorganized; prior-period segment results were recast.
Financial results and key metrics
| Metric | Q3 FY2011 | Q3 FY2010 | Nine months FY2011 | Nine months FY2010 |
|---|---|---|---|---|
| Net sales | $3,729 million | $3,084 million | $10,401 million | $8,933 million |
| Gross margin | $1,125 million; 30.2% | $985 million; 31.9% | $3,190 million; 30.7% | $2,784 million; 31.2% |
| Operating income | $471 million; 12.6% | $467 million; 15.1% | $1,276 million; 12.3% | $1,134 million; 12.7% |
| Net income attributable to TE Connectivity | $355 million | $330 million | $919 million | $806 million |
| Diluted EPS | $0.80 | $0.72 | $2.06 | $1.75 |
| Operating cash flow | Not separately stated | Not separately stated | $1,149 million | $1,205 million |
- Reported sales rose 20.9% in Q3 and 16.4% year to date; organic growth was 4.9% and 7.8%, respectively. Q3 sales included $311 million from ADC, while foreign-exchange translation added $208 million.
- Q3 operating income was nearly flat despite higher sales. Gross margin and operating margin contracted, with price erosion, higher material costs, Japan-related disruption, and acquisition-related costs among the pressures.
- Nine-month operating cash flow declined $56 million year over year, primarily due to lower accrued current liabilities and higher income taxes paid. Capital expenditures were $375 million, versus $249 million a year earlier.
- Cash and cash equivalents were $1,212 million at June 24, 2011, down from $1,990 million at September 24, 2010. Total debt was $2,655 million, up from $2,413 million; long-term debt was $2,654 million. The company had no borrowings on its new $1.5 billion revolving facility.
- Current assets were $6,860 million and current liabilities $3,691 million. The filing reports a five-year revolving credit facility and compliance with debt covenants, including a leverage covenant trigger above 3.5 times debt to EBITDA.
- Segment results were mixed: Transportation Solutions Q3 sales were $1,426 million and operating income $211 million, up from $1,214 million and $159 million. Communications and Industrial Solutions sales were $1,297 million and operating income $134 million, versus $1,258 million and $205 million. Network Solutions sales were $1,006 million and operating income $126 million, versus $612 million and $96 million; its sales increase included ADC.
Material changes and unusual items
- ADC contributed $641 million in sales and an operating loss of $77 million from acquisition through June 24. That loss included $60 million of restructuring charges, $40 million of acquisition-accounting amortization adjustments, and $19 million of acquisition and integration costs. Management expected approximately $130 million of annualized savings from ADC-related restructuring, with about 40% expected in FY2011.
- Fiscal 2011 included a $35 million tax benefit tied to U.S. tax matters and $14 million of related other expense under the tax-sharing agreement. The lower effective tax rate—17.2% in Q3 and 22.0% year to date, versus 30.3% and 30.1%—also reflected jurisdictional income mix and prior-year tax items.
- Other income was $13 million for the nine months, versus $125 million in the prior-year period, primarily reflecting changes in tax-sharing-agreement items.
- A non-U.S. pension plan amendment reduced pension and postretirement liabilities by $179 million through other comprehensive income in Q3.
- Share repurchases totaled $564 million in the first nine months, and shareholder distributions and dividends totaled $220 million. The quarterly cash distribution was $0.18 per share.
Guidance, management commentary, and risks
- For FY2011, management forecast sales of $14.3–$14.4 billion, growth of 18%–19%, and diluted continuing-operations EPS of $2.83–$2.87, including about $0.05 per share from the 53rd week. Q4 guidance was sales of $3.9–$4.0 billion and diluted continuing-operations EPS of $0.76–$0.80. The outlook assumed then-current foreign-exchange and commodity rates.
- Management estimated the Japan earthquake reduced Q3 sales by $68 million and diluted EPS by $0.05; full-year impacts were estimated at $118 million and $0.08 per share. It did not expect a material FY2012 impact. Management cited stronger automotive, network-infrastructure, and industrial markets, partly offset by weakness in subsea communications and consumer devices.
- Raw-material prices had increased: Q3 average copper was $4.03 per pound, gold $1,409 per troy ounce, and silver $33.64 per troy ounce. Management expected elevated prices to continue. About 55% of sales were invoiced in currencies other than the U.S. dollar.
- Management expected approximately $250 million of net cash payments for pre-separation tax matters over the following 12 months, including about $160 million in Q4 FY2011. Tax outcomes remain uncertain; the company disclosed $1,313 million of accrued interest and penalties related to uncertain tax positions.
- The State of New York dispute remains a significant contingency: the State alleged damages exceeding $275 million, had drawn $50 million under a letter of credit, and could draw up to another $50 million. A trial was scheduled for February 2012. A separate Com-Net contingent payment of up to $80 million was not accrued because management did not consider payment probable or reasonably estimable.
- Other disclosed risks include ADC integration and synergy execution, pricing pressure and material costs, end-market and foreign-exchange volatility, tax disputes, and litigation. Management stated ordinary-course legal matters were not expected, individually or in aggregate, to have a material adverse effect, while noting outcomes remain uncertain.
Important facts for investors to verify
- Whether reported growth translates into sustained organic growth and margin recovery, given Q3 margin declines and price and input-cost pressures.
- ADC’s progress toward integration, profitability, and the stated annualized cost savings, including remaining restructuring charges and cash costs.
- Actual cash generation and liquidity after planned tax payments, capital spending, shareholder distributions, and share repurchases.
- Developments in pre-separation IRS matters and the New York contract litigation, including potential reimbursements, additional letter-of-credit draws, and timing of cash outflows.
- Performance against FY2011 and Q4 guidance, particularly the assumed currency and commodity rates and the estimated Japan-related impact.