TE Connectivity Ltd. — Form 10-Q Summary
Reporting period: First quarter of fiscal 2012, ended December 30, 2011; comparison is the quarter ended December 24, 2010. Financial amounts are in U.S. dollars unless stated otherwise. The filing identifies the registrant as TE Connectivity Ltd.
Financial performance
| Metric | Q1 FY2012 | Q1 FY2011 |
|---|---|---|
| Net sales | $3.309 billion | $3.200 billion |
| Gross margin | $983 million; 29.7% | $1.021 billion; 31.9% |
| Operating income | $378 million; 11.4% of sales | $400 million; 12.5% of sales |
| Income from continuing operations | $254 million | $269 million |
| Net income attributable to TE Connectivity | $260 million; diluted EPS $0.61 | $265 million; diluted EPS $0.59 |
| Net cash from continuing operating activities | $210 million | $154 million |
| Free cash flow (non-GAAP) | $85 million | $45 million |
Revenue grew 3.4% as reported, but declined 2.6% organically; acquisition contributions of $185 million, principally ADC, more than offset organic contraction. Gross margin fell on lower volume and higher material costs, partly offset by ADC sales and manufacturing productivity. R&D expense increased to $184 million from $163 million. The effective tax rate was 26.6%, versus 29.6%.
Segments and material changes
- Transportation Solutions: Sales rose 7.2% to $1.405 billion; operating income increased to $223 million from $189 million, and margin improved to 15.9% from 14.4%. Automotive and aerospace, defense, and marine markets grew organically.
- Communications and Industrial Solutions: Sales fell 12.1% to $1.075 billion; operating income declined to $76 million from $181 million, and margin fell to 7.1% from 14.8%. Organic sales dropped 12.9%, amid weakness and inventory corrections across industrial, consumer devices, data communications, and appliance markets.
- Network Solutions: Sales increased 24.5% to $829 million, reflecting ADC; organic sales declined 2.6%. Operating income rose to $79 million from $30 million, with prior-year ADC acquisition and integration charges affecting comparability.
Cash, debt and liquidity
- Cash and cash equivalents were $1.390 billion at December 30, up from $1.219 billion at September 30, 2011. Current assets were $6.577 billion and current liabilities $3.820 billion.
- Total debt was $2.846 billion, versus $2.669 billion at fiscal year-end; $896 million was classified as current, including $716 million of 6.00% notes due in October 2012. Commercial paper outstanding was $179 million.
- The company had no borrowings on its $1.5 billion five-year revolver or new $700 million 364-day facility, and reported compliance with debt covenants. The facilities include a maximum consolidated debt-to-EBITDA covenant of 3.5:1.
- Operating cash flow improved partly through working capital; capital expenditures were $130 million. Fiscal 2012 capital spending was expected to be 4%–5% of sales. Free cash flow is a company-defined non-GAAP measure.
Outlook, management commentary and unusual items
- Management forecast Q2 FY2012 sales of $3.3–$3.4 billion and diluted EPS of $0.57–$0.61. For FY2012, it forecast sales of $13.8–$14.2 billion and diluted EPS of $2.70–$2.90. These forecasts excluded the proposed Deutsch acquisition and assumed then-current foreign exchange and commodity rates.
- Management expected automotive production growth, while citing weak data communications and industrial spending, supply-chain inventory corrections, slower North American telecom carrier spending, and lower subsea project activity. It anticipated improvement in some segments in the second half of the fiscal year.
- The proposed acquisition of Deutsch was valued at €1.15 billion in seller consideration, with total transaction value of about €2.0 billion including debt repayment. Closing was expected by the end of Q3 FY2012, subject to regulatory approvals; a €50 million termination fee could be payable if the deal did not close. The company intended to fund it with approximately $1 billion of cash and approximately $1 billion of financing.
- Restructuring charges were $19 million for the quarter. Management expected approximately $90 million of FY2012 charges, total FY2012 restructuring cash spending of about $175 million, and annualized savings of approximately $145 million. Cash spending across restructuring plans was $42 million in Q1; the separately disclosed fiscal 2012 action program used $3 million.
- Discontinued operations included an $21 million pre-tax partial recovery related to a favorable New York State contract judgment; the court awarded the company $25 million and dismissed the State’s counterclaim with prejudice. A separate $5 million charge related to an unfavorable judgment reduced discontinued-operations income.
- Other notable exposure: $1.305 billion of accrued interest and penalties on uncertain tax positions; expected net cash payments of about $70 million over the next 12 months for pre-separation tax matters; and a $12 million recorded environmental reserve against a probable estimated cost range of $12–$23 million. Management cautioned that ultimate tax resolution could materially affect results, financial position, or cash flows.
- Risks include the Deutsch transaction and integration, cyclical end markets, pricing pressure, commodity and currency movements, customer and supplier conditions, litigation, and tax matters. A 10% currency move would change the unrealized value of foreign-exchange forwards by approximately $99 million, with management expecting offsets from underlying positions.
Most important facts for investors to verify
- Whether the sales and EPS outlook was achieved, particularly given negative organic growth and the sharp Communications and Industrial Solutions decline.
- Whether expected restructuring savings materialized and whether cash costs stayed within the stated plans.
- Deutsch closing status, final financing and purchase cost, regulatory conditions, and integration results.
- Repayment or refinancing of the $716 million 6.00% notes due in October 2012, and ongoing covenant headroom.
- Developments in IRS examinations and pre-separation tax obligations, including the substantial accrued interest and penalties.
- Collection and timing of the $25 million New York judgment and resolution of the separate Com-Net contingent claim, whose maximum stated amount was $80 million and for which no liability was recorded.