TE Connectivity Ltd. — Q2 FY2020 Form 10-Q
Reporting period: Quarter and six months ended March 27, 2020. Figures are in U.S. dollars; amounts are in millions except per-share data. TE Connectivity supplies connectivity and sensor products across transportation, industrial, communications, and other markets.
Financial results
| Metric | Q2 FY2020 | Q2 FY2019 | Six months FY2020 | Six months FY2019 |
|---|---|---|---|---|
| Net sales | $3,195 | $3,412 | $6,363 | $6,759 |
| Gross margin | $1,029; 32.2% | $1,118; 32.8% | $2,059; 32.4% | $2,232; 33.0% |
| Operating income (loss) | $(415) | $530 | $56 | $1,014 |
| Net income (loss) | $(456) | $439 | $(430) | $715 |
| Diluted EPS | $(1.37) | $1.29 | $(1.29) | $2.09 |
- Q2 sales declined 6.4% year over year (5.4% organically); six-month sales declined 5.9% (5.1% organically). COVID-19, lower volumes, price erosion, and currency translation weighed on results.
- Q2 cost of sales was 67.8% of sales versus 67.2% a year earlier. Management attributed lower gross margin mainly to lower volume and price erosion, partly offset by lower material costs.
- Operating loss included a $900 goodwill impairment charge in the Transportation Solutions Sensors reporting unit. The reported Q2 operating margin was negative 13.0%; excluding the impairment and other listed special charges, reported operating income still faced lower volume and pricing pressure.
- Six-month income tax expense was $489, including $355 related primarily to Swiss tax reform and the write-down of deferred tax assets. The Q2 tax expense was $42 and included a $31 benefit from settling pre-separation tax matters and terminating the Tax Sharing Agreement.
- Six-month net cash from continuing operations was $892, versus $883 in the prior-year period. Capital expenditures were $309, implying approximately $583 of operating cash flow less capital expenditures. Cash and cash equivalents were $796 at period-end, down $131 from fiscal year-end.
Balance sheet, debt, and liquidity
- At March 27, 2020, total debt was $4,355 ($603 short-term and $3,752 long-term), up from $3,965 at September 27, 2019. Cash was $796; debt net of cash was approximately $3,559.
- Current assets were $5,715 and current liabilities $3,959. Total assets were $19,367 and total equity $9,171.
- The company issued €550 million of 0.0% senior notes due February 2025. It had no commercial paper outstanding at quarter-end and no borrowings on its $1.5 billion revolving credit facility. It reported compliance with debt covenants.
- Management said available financial resources, operating cash flow, and capital-structure flexibility should meet foreseeable needs, including debt maturities and anticipated payments to First Sensor minority shareholders. Fiscal 2020 capital spending was expected to be about $575.
Material changes and segment performance
- Transportation Solutions sales declined 5.8% in Q2; operating loss was $606, including the $900 impairment. Automotive, commercial transportation, and sensor markets weakened.
- Industrial Solutions sales declined 4.5% in Q2, while operating income rose to $142 from $137. Weak industrial-equipment demand was partly offset by growth in medical and energy markets and strength in defense.
- Communications Solutions sales declined 13.4% in Q2 and operating income fell to $49 from $77, reflecting weakness in data and devices and appliances.
- In March, TE acquired approximately 72% of First Sensor AG for €209 million ($232 million). It also acquired three other businesses for $124 million net of cash. First Sensor purchase-price allocation remained preliminary.
- Fiscal 2020 share repurchases were $423 for five million shares; dividends paid were $307. The company approved a $1.92-per-share dividend, payable in four quarterly installments of $0.48 beginning in Q3.
Outlook, risks, and unusual items
- Management expected Q3 FY2020 sales to decline approximately 25% from Q2’s $3.2 billion, driven mainly by automotive and commercial aerospace weakness and supply-chain adjustments. It estimated global automotive production would fall about 33% sequentially, with an additional approximately $200 impact from customer inventory builds and approximately $100 of sales impact from supply-chain disruptions. Defense and data-and-devices strength were expected to partially offset declines.
- Management withdrew full-year FY2020 guidance because COVID-19 made future demand difficult to forecast. It warned that the pandemic could materially affect near-term results and potentially future financial condition, liquidity, and results.
- Further goodwill impairment is possible if economic conditions deteriorate or remain depressed. The Sensors unit retained $626 of goodwill after the charge; its estimated fair value was $1.0 billion, based partly on Level 3 cash-flow assumptions.
- SubCom sale-related performance guarantees totaled approximately $1.2 billion at quarter-end and may remain outstanding through fiscal 2025. No new post-sale guarantees were outstanding; management said it did not expect to have to perform, citing contractual recourse.
- Environmental remediation costs were estimated at a reasonably possible $14–$45 range, with $17 accrued. Management did not expect ordinary legal proceedings or these environmental matters to have a material financial effect.
- Other notable items: the $900 goodwill impairment; $355 of six-month tax expense from Swiss tax reform; and termination of the Tax Sharing Agreement, which generated a $31 tax benefit and $8 of other income in Q2.
Important facts for investors to verify
- How quickly automotive, commercial aerospace, and other end markets recover, and whether Q3 sales develop in line with management’s estimate.
- Whether COVID-19-related shutdowns, supply-chain disruption, or customer payment stress materially affect future cash flow and liquidity.
- The assumptions behind the Sensors reporting unit valuation and the risk of additional impairment.
- The final First Sensor purchase-price allocation and the timing and cost of minority-shareholder compensation under the DPLTA.
- Cash needs for debt maturities, dividends, restructuring, share repurchases, and SubCom guarantees.
- The effect of Swiss tax reform and other tax matters on future tax expense and cash taxes.