TE Connectivity Ltd. — Q1 Fiscal 2015 Form 10-Q
Reporting period: Quarter ended December 26, 2014; comparisons are with the quarter ended December 27, 2013. The filing identifies the registrant as TE Connectivity Ltd. and presents unaudited U.S. GAAP results in U.S. dollars.
Financial results and position
| Metric | Q1 FY2015 | Q1 FY2014 |
|---|---|---|
| Net sales | $3.466 billion | $3.326 billion |
| Gross margin | $1.171 billion; 33.8% | $1.117 billion; 33.6% |
| Operating income | $477 million | $479 million |
| Income from continuing operations | $472 million | $355 million |
| Net income attributable to TE Connectivity | $472 million | $353 million |
| Diluted EPS | $1.14 | $0.85 continuing operations; $0.84 net income |
| Operating cash flow | $295 million | $385 million |
| Free cash flow (non-GAAP) | $162 million | $266 million |
Net income benefited substantially from a $95 million income tax benefit, including a $189 million benefit from effective settlement of undisputed pre-separation tax matters. Other expense included an $83 million reduction in related indemnification receivables. These items make reported earnings less directly comparable year over year.
At December 26, 2014, cash and cash equivalents were $868 million, total debt was $4.223 billion, current assets were $6.045 billion and current liabilities were $3.876 billion. Cash declined $1.589 billion during the quarter, principally reflecting the Measurement Specialties acquisition. The company reported $597 million of commercial paper outstanding and no borrowings under its $1.5 billion revolving credit facility; it was in compliance with debt covenants. Capital expenditures were $142 million.
Changes and business drivers
- Reported sales rose 4.2%; organic sales increased 3.4%. Foreign exchange reduced sales by $139 million, while acquisitions added $166 million, including $125 million from Measurement Specialties.
- Transportation Solutions sales increased 11.9% (7.9% organic); Industrial Solutions rose 2.8% (2.7% organic); Network Solutions declined 1.3% reported but grew 1.9% organically; Consumer Solutions declined 10.7% reported and 8.5% organically.
- Operating income was nearly flat despite higher sales. Gross margin percentage improved modestly. SG&A fell to $459 million from $467 million, while R&D rose to $184 million from $164 million. Acquisition/integration costs were $24 million and restructuring charges were $27 million, versus $7 million of restructuring charges a year earlier.
- Segment operating income increased in Network Solutions, but declined in Industrial and Consumer Solutions. Transportation Solutions operating margin fell to 18.8% from 20.6%, including Measurement Specialties’ $28 million operating loss and acquisition-related charges.
Outlook, events and risks
- Management forecast Q2 FY2015 sales of $3.55–$3.65 billion and diluted EPS of $0.89–$0.93. Fiscal 2015 guidance was sales of $14.45–$14.85 billion and diluted EPS of $4.04–$4.34.
- Guidance included estimated foreign-exchange headwinds of approximately $250 million of sales and $0.10 per share in Q2, and $900 million of sales and $0.35 per share for FY2015. Forecasts assumed current foreign-exchange rates and commodity prices.
- On January 27, 2015, the company agreed to sell Broadband Network Solutions for $3.0 billion cash, subject to working-capital adjustment, regulatory approvals and other closing conditions. Closing was expected in calendar 2015; the business was to be reported as discontinued operations beginning Q2 FY2015. The board also authorized a $3.0 billion increase in the share repurchase program.
- Management expected approximately $65 million of restructuring charges in FY2015, including $15 million related to Measurement Specialties; cash spending was expected to be about $105 million. Annualized savings of approximately $20 million were expected by the end of FY2016.
- Tax contingency: A disputed IRS matter concerning historical intercompany debt remains in Tax Court, with trial set for February 2016. If the IRS prevails, TE Connectivity’s share of taxes, interest and penalties could materially affect results, financial position or cash flows. Management stated that it believed reserves were appropriate. About $50 million of net cash payments for pre-separation tax matters were expected over the next 12 months.
- Other matters include a Com-Net lawsuit in which sellers claimed at least $135 million; no liability was recorded because payment was not considered probable or reasonably estimable. Environmental remediation costs were estimated at $17–$40 million, with $21 million as the best estimate. Management did not expect ordinary-course legal matters or specified guarantees to have a material effect, but outcomes remain uncertain.
- Key stated risks include economic and end-market weakness, competition and pricing pressure, raw-material costs and availability, currency movements, acquisition and divestiture execution, litigation, and debt-covenant limitations. Management reported effective disclosure controls.
Most important facts for investors to verify
- How much of the earnings and EPS increase reflects the tax benefit and other unusual tax-sharing items, rather than recurring operations.
- Whether Measurement Specialties can improve from its reported first-quarter operating loss and deliver expected integration benefits.
- Whether the BNS sale closes on expected terms and timing, and the effects of its separation from Network Solutions and future reported results.
- Whether operating cash generation recovers after the acquisition-related cash outflow, and how debt, commercial paper and planned repurchases affect liquidity.
- Developments in the IRS intercompany-debt dispute, related reserves and expected pre-separation tax payments.
- Whether fiscal 2015 sales and EPS guidance remains achievable given currency headwinds, consumer-device weakness, oil-and-gas softness and pricing pressure.