TE Connectivity (Tyco Electronics Ltd.) — Q1 FY2011 Form 10-Q
Reporting period: Quarter ended December 24, 2010; comparable quarter ended December 25, 2009. The filing registrant is Tyco Electronics Ltd., the predecessor name reflected in the supplied filing text.
Business context and results
The company designs, manufactures, and markets connectivity products across automotive, communications, industrial, aerospace, medical, energy, and other markets. Beginning this quarter, it reported three segments: Transportation Connectivity, Communications and Industrial Solutions, and Network Solutions. ADC Telecommunications, acquired in December, is included in Network Solutions.
| Metric | Q1 FY2011 | Q1 FY2010 |
|---|---|---|
| Net sales | $3.200 billion | $2.892 billion |
| Gross margin | $1.021 billion; 31.9% | $841 million; 29.1% |
| Operating income | $400 million; 12.5% of sales | $269 million; 9.3% of sales |
| Income from continuing operations | $269 million | $173 million |
| Net income attributable to Tyco Electronics | $265 million | $172 million |
| Diluted EPS | $0.59 ($0.60 continuing operations) | $0.37 |
| Operating cash flow | $154 million | $330 million |
| Capital expenditures | $117 million | $76 million |
Reported sales increased 10.7%; organic sales increased 11.4%. Foreign exchange reduced sales by $33 million, while price erosion reduced sales by $60 million. Higher volume and manufacturing productivity supported margin improvement; price erosion, higher material costs, and unfavorable product mix were offsets. The effective tax rate was 29.6%, versus 28.5%.
Segments and material changes
- Transportation Connectivity: Sales $1.311 billion, up 11.2%; operating income $189 million versus $99 million. Organic sales rose 15.5%, led by automotive.
- Communications and Industrial Solutions: Sales $1.223 billion, up 12.2%; operating income $181 million versus $115 million. Organic growth was 12.8%, led by industrial, DataComm, and appliance markets.
- Network Solutions: Sales $666 million, up 6.9%; operating income fell to $30 million from $55 million. ADC added $51 million of sales, but its brief post-acquisition period contributed a $57 million operating loss, including restructuring, integration, acquisition, and purchase-accounting charges. Organic sales rose 1.6%; subsea communications remained weak.
The December 9 ADC acquisition cost approximately $717 million in cash, net of $546 million cash acquired, plus $22 million fair value of exchanged share awards. The preliminary purchase-price allocation included $523 million goodwill and $300 million acquired intangible assets, and remains subject to revision. The company expects ADC synergies and cost savings.
Cash, debt, liquidity, and capital allocation
Cash and equivalents were $1.407 billion at quarter-end, down from $1.990 billion at September 24, 2010. Total debt was $3.215 billion, up from $2.413 billion; $660 million was classified as current. Debt increased in part due to ADC-related obligations and a $250 million senior-note issuance. The company had no borrowings under its $1.425 billion revolving credit facility and reported compliance with debt covenants, including the 3.5-to-1 debt-to-EBITDA covenant.
Operating cash flow declined to $154 million, primarily reflecting inventory growth and lower accrued liabilities, partly offset by higher earnings. Investing cash outflow was $793 million, including the $717 million ADC cash acquisition and $117 million capital spending. Financing provided $53 million. Management stated cash generation and available funding should meet foreseeable capital needs. The company repurchased $45 million of shares and paid $71 million in distributions; the quarterly distribution was $0.16 per share.
Outlook, management commentary, and risks
- Q2 FY2011 sales guidance: $3.45–$3.55 billion, up 17%–20% year over year; diluted EPS guidance: $0.60–$0.64.
- FY2011 guidance: sales of $13.9–$14.3 billion, up 15%–18%; diluted EPS of $2.75–$2.90, including about $0.05 from the 53rd week. Outlook assumes current foreign-exchange and commodity rates.
- ADC integration restructuring is expected to cost about $75 million through FY2013, with approximately $100 million in annualized savings when fully implemented. Manufacturing simplification is expected to incur about $15 million in FY2011 charges and generate approximately $25 million in annualized savings.
- Management cited global economic and end-market demand, competition and pricing, raw-material costs, currencies, suppliers, acquisitions, debt limitations, and litigation among key risks. Copper and gold prices were higher year over year.
- The State of New York dispute remains significant: the State alleges damages exceeding $275 million and may draw up to another $50 million under a letter of credit; the company disputes the State’s claims. Trial was scheduled for October 2011.
- Unresolved pre-separation tax matters remain uncertain. The filing reports $1.289 billion of accrued interest and penalties on uncertain tax positions and $244 million of liabilities related to specified IRS audits. Management warned ultimate resolution could materially affect results, financial position, or cash flows.
- Environmental remediation reserves were $15 million. The company also disclosed ongoing FCPA-related compliance review matters, but said recorded amounts were not significant. ADC controls had not yet been fully assessed.
Important facts for investors to verify
- Track ADC integration costs, final purchase accounting, realized synergies, and whether Network Solutions operating performance improves.
- Compare subsequent sales, margins, and cash conversion with the stated Q2 and FY2011 guidance; monitor inventory and accrued-liability movements.
- Review debt and liquidity after ADC note repurchases: subsequent to quarter-end, $471 million principal of ADC convertible notes was purchased and cancelled.
- Follow the New York contract litigation, potential additional letter-of-credit draw, and the related contingent exposure.
- Monitor IRS and other tax exposures, including the substantial accrued interest and penalties and the shared-liability arrangements with Tyco International and Covidien.