TE Connectivity Ltd. — Form 10-Q Summary
Business context and reporting period
TE Connectivity Ltd. is a global connectivity and sensor solutions manufacturer serving transportation, industrial, communications, and other markets. This unaudited filing covers the quarter ended March 30, 2018 (fiscal 2018 second quarter) and the six months then ended; comparisons are with the corresponding fiscal 2017 periods. Unless noted, amounts are in U.S. dollars.
Financial performance and condition
| Metric | Fiscal Q2 2018 | Fiscal Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Net sales | $3.745B | $3.227B | $7.225B | $6.290B |
| Operating income | $624M | $481M | $1.205B | $976M |
| Operating margin | 16.7% | 14.9% | 16.7% | 15.5% |
| Net income | $490M | $405M | $450M | $814M |
| Diluted EPS, continuing operations | $1.39 | $1.13 | $1.28 | $2.26 |
| Operating cash flow | Not presented by quarter | $727M | $925M |
- Quarterly sales grew 16.1%; organic sales growth, a non-GAAP measure, was 6.9%. For the six months, sales grew 14.9%, including 7.4% organic growth. Foreign exchange added $235M to quarterly sales and $350M to six-month sales; acquisitions added $62M and $124M, respectively.
- Gross margin dollars rose, but gross margin percentage fell to 33.2% from 34.4% in Q2 and to 33.5% from 34.6% for the six months. Management cited higher volume, favorable currency and lower material costs as benefits, partly offset by price erosion and subsea production delays. Price erosion reduced organic sales by $49M in Q2 and $93M year to date.
- Quarterly net income increased, while six-month net income fell substantially. Six-month income tax expense was $708M, including a $567M charge related primarily to revaluing U.S. deferred tax assets after the Tax Cuts and Jobs Act. The six-month effective tax rate was 61.0%, versus 10.3% a year earlier; Q2 rates were 18.0% and 8.8%.
- At March 30, cash was $559M, total current assets $5.960B, and current liabilities $4.164B (current ratio approximately 1.43). Total debt was $4.010B, versus $4.344B at September 29, 2017; cash was $1.218B at that prior date. Debt included $675M short-term and $3.335B long-term.
- Six-month operating cash flow declined $198M to $727M, primarily due to compensation payments and unfavorable working-capital changes, partly offset by higher pretax income. Capital expenditures were $447M versus $289M; operating cash flow less capex was $280M, a simple derived measure. Financing outflows included $381M of share repurchases and $281M of dividends.
- By segment, Q2 sales/operating income were Transportation Solutions $2.134B/$428M, Industrial Solutions $972M/$126M, and Communications Solutions $639M/$70M. Communications operating income declined from $88M; Transportation and Industrial operating income increased from $305M and $88M, respectively.
Material changes, outlook, and management commentary
- Transportation Solutions sales increased 21.6% in Q2, supported by growth across end markets, acquisitions, and currency. Industrial Solutions sales increased 14.0%, led by industrial equipment. Communications Solutions sales increased 3.2% in Q2, but declined 0.6% for the six months as subsea communications weakness outweighed growth in appliances and data and devices.
- Management forecast Q3 fiscal 2018 sales of $3.65B–$3.70B and fiscal-year sales of $14.5B–$14.7B. Forecast diluted EPS from continuing operations was $1.13–$1.15 for Q3 and $3.70–$3.76 for fiscal 2018. The outlook assumed currency rates and commodity prices consistent with current levels and included estimated favorable currency contributions versus prior-year periods.
- Management expected fiscal 2018 subsea communications sales of $700M–$750M. It anticipated automotive production growth of approximately 2% for fiscal 2018, continued factory automation strength, and subsea declines that would more than offset growth in communications appliances and data/devices.
- Fiscal 2018 restructuring actions, primarily in Industrial Solutions, were expected to generate about $30M in annualized savings by the end of fiscal 2019. The company expected approximately $150M of net restructuring charges and $130M of restructuring spending in fiscal 2018.
- TE Connectivity repaid $708M of 6.55% notes at maturity, had $225M of commercial paper outstanding, and had borrowed €100M under an uncommitted facility due December 2018. It also had $325M of 2.375% notes due December 2018. Management said operating cash and potential funding sources should cover anticipated needs and reported compliance with debt covenants; the $1.5B revolving facility had no borrowings.
Risks, contingencies, and unusual items
- The tax-law charge materially distorts year-to-date earnings comparisons. The company noted that future IRS guidance could affect its treatment of deferred tax assets related to interest carryforwards, although April 2018 IRS notice indicated intent to issue rules consistent with the company’s interpretation.
- Environmental investigation and remediation costs were estimated at $15M–$45M; $19M was accrued. The company stated it did not expect the estimated costs to have a material adverse effect. It also disclosed $285M in letters of credit, guarantees, and surety bonds, and $46M in warranty accruals.
- Management did not expect ordinary-course legal proceedings, guarantees, or remaining shared tax matters to materially affect results, financial position, or cash flows. These outcomes remain subject to uncertainty.
- Disclosed business risks include economic and industry cyclicality, automotive demand, pricing pressure, raw-material costs and availability, foreign exchange, suppliers, acquisitions, operational interruptions, cybersecurity, litigation, regulation, debt restrictions, and tax-law changes. The filing added a risk that U.S. shareholders treated as owning at least 10% may face additional tax reporting and income-inclusion obligations under changed CFC rules.
- Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether reported sales growth converts into sustained organic growth, and how much growth continues to depend on currency and acquisitions.
- Whether gross-margin pressure, price erosion, and raw-material costs improve, and whether expected restructuring savings are achieved on schedule.
- How quickly subsea production delays resolve and whether the fiscal-year subsea sales outlook is met.
- The cash-flow and liquidity effects of working-capital needs, capital spending, the December 2018 debt maturities, dividends, and continued share repurchases.
- The final tax impact of the Tax Cuts and Jobs Act and any subsequent guidance affecting deferred tax assets or U.S. shareholder obligations.