Business context and reporting period
TE Connectivity Ltd. (the registrant named in the filing) designs and manufactures connectivity and sensor products. This unaudited Form 10-Q covers the quarter ended March 27, 2015 (fiscal Q2 2015) and the six months then ended; comparisons are with the corresponding 2014 periods. The company reorganized its reporting segments into Transportation Solutions, Industrial Solutions, and Communications Solutions, and restated prior-period segment results.
Financial performance
| Metric | Quarter | Six months |
|---|---|---|
| Net sales | $3.082 billion, up 4.0% | $6.131 billion, up 5.2% |
| Organic sales growth | 6.2% | 5.6% |
| Gross margin | $1.051 billion; 34.1% of sales versus 33.6% | $2.071 billion; 33.8% versus 33.3% |
| Operating income | $448 million versus $471 million | $873 million versus $890 million |
| Continuing-operations income | $316 million versus $340 million | $751 million versus $653 million |
| Net income | $599 million versus $362 million | $1.071 billion versus $715 million |
| Diluted EPS | $1.45; continuing operations $0.77 | $2.59; continuing operations $1.82 |
Quarterly sales growth was led by Communications Solutions; the acquisition of Measurement Specialties contributed $138 million of quarterly sales ($263 million for the six months). Currency translation reduced sales by $246 million in the quarter and $367 million year to date. Price erosion reduced organic sales by $44 million and $91 million, respectively. Gross-margin improvement reflected higher volume and productivity, partly offset by price erosion.
Segment sales and operating income for the quarter were: Transportation Solutions, $1.610 billion and $323 million (operating margin 20.1%, versus 21.5%); Industrial Solutions, $797 million and $84 million (10.5%, versus 12.9%); Communications Solutions, $675 million and $41 million (6.1%, versus 5.1%). Communications growth reflected subsea project activity, while Data and Devices sales declined. Industrial operating income was pressured by restructuring and acquisition charges, as well as market weakness in oil and gas.
Cash flow, liquidity, and debt
For the six months, operating cash flow was $693 million, including $555 million from continuing operations, versus $834 million and $740 million, respectively, in 2014. Capital expenditures were $291 million. Management’s non-GAAP free cash flow was $296 million versus $459 million. Investing cash use was $2.030 billion, primarily reflecting $1.729 billion of acquisitions; financing cash use was $383 million. Cash fell by $1.760 billion to $697 million, mainly reflecting acquisition spending.
At March 27, 2015, current assets were $7.612 billion and current liabilities $4.141 billion. Total debt was $4.126 billion, compared with $3.858 billion at September 26, 2014; cash was $697 million. A $500 million floating-rate note maturity was classified as current and is due in January 2016. The company issued €550 million (about $617 million) of 1.1% notes due 2023 and reported no borrowings under its $1.5 billion revolving credit facility. It said it expected available operating cash and other funding sources to meet foreseeable needs and reported compliance with debt covenants.
Material changes, outlook, and risks
- Discontinued business: TE agreed to sell Broadband Network Solutions (BNS) for $3.0 billion cash, subject to working-capital adjustment and customary approvals, with closing expected in calendar 2015. BNS is presented as discontinued operations. The quarter’s $283 million of discontinued-operations income included a $228 million tax benefit, primarily from deferred tax assets expected to be realized on the sale; net income growth therefore did not reflect continuing-operations performance.
- Acquisition and restructuring: Measurement Specialties was acquired in October 2014 for approximately $1.7 billion net of cash acquired. Fiscal 2015 restructuring charges were $63 million for the first six months; management expected about $75 million for the year, approximately $105 million of cash spending, and annualized savings of about $60 million by the end of fiscal 2016.
- Guidance: For fiscal Q3 2015, management forecast sales of $3.13–$3.23 billion and continuing-operations diluted EPS of $0.80–$0.84. For fiscal 2015, it forecast sales of $12.35–$12.65 billion and continuing-operations diluted EPS of $3.51–$3.65. These outlooks included estimated currency headwinds of about $330 million of sales and $0.13 per share for Q3, and $1.01 billion and $0.38 per share for the fiscal year. Management cited anticipated subsea strength, automotive growth, and oil-and-gas weakness; outlook assumed exchange rates and commodity prices consistent with then-current levels.
- Tax and legal contingencies: The unresolved IRS dispute over pre-separation intercompany debt could have a material effect if decided adversely. IRS assessments disclosed by Tyco included $778 million of additional tax, $154 million of penalties, and $105 million of withholding taxes, excluding interest and possible subsequent-year effects; TE bears a 31% share under the tax-sharing agreement. Management said it believed reserves were appropriate. A separate Com-Net lawsuit sought at least $135 million; trial began in March 2015, and no liability was recorded because management did not consider payment probable. Estimated environmental remediation costs were $17–$39 million, with a $20 million best estimate.
- Other exposures: Foreign exchange, raw-material prices, pricing pressure, demand in served markets, acquisitions and the planned BNS sale are identified risks. Currency translation also contributed to a $425 million six-month other comprehensive loss. Management reported no material change in market-risk exposures and effective disclosure controls.
Most important facts for investors to verify
- Whether the BNS sale closes on the expected terms and timing, and how its proceeds are used.
- Whether organic growth and segment profitability persist after separating acquisition effects, currency impacts, and restructuring charges.
- Whether cash generation improves, given lower free cash flow and the January 2016 $500 million debt maturity.
- The realization and timing of the projected restructuring savings and cash costs.
- Developments in the IRS tax dispute and Com-Net litigation, including any changes to reserves, cash exposure, or reported tax benefits.
- Actual results against fiscal Q3 and full-year sales and continuing-operations EPS guidance, particularly under currency and oil-and-gas market pressures.