TE Connectivity Ltd. — Fiscal 2015 Third-Quarter Form 10-Q
Reporting period: Quarter ended June 26, 2015; year-to-date results cover the nine months then ended. Unless noted, amounts are U.S. dollars. The company designs and manufactures connectivity and sensor solutions and reports through Transportation, Industrial, and Communications Solutions. It reorganized its segments during fiscal 2015; prior-period segment results were restated.
Financial performance
| Metric | Q3 FY2015 | Q3 FY2014 | Nine months FY2015 | Nine months FY2014 |
|---|---|---|---|---|
| Net sales | $3.118B | $3.075B | $9.249B | $8.901B |
| Gross margin | $1.048B; 33.6% | $1.018B; 33.1% | $3.119B; 33.7% | $2.958B; 33.2% |
| Operating income | $469M | $464M | $1.342B | $1.354B |
| Continuing-operations income | $351M | $347M | $1.102B | $1.000B |
| Net income attributable to TE Connectivity | $309M | $403M | $1.380B | $1.118B |
| Diluted EPS, continuing operations | $0.85 | $0.83 | $2.67 | $2.40 |
| Diluted EPS, total | $0.75 | $0.97 | $3.34 | $2.68 |
- Reported sales rose 1.4% for the quarter and 3.9% year to date. Organic sales growth was 4.2% and 5.1%, respectively; foreign exchange reduced sales by $278M and $642M, while price erosion reduced organic sales by $63M and $154M.
- Quarterly gross margin improved 0.5 percentage points, supported by manufacturing productivity and volume. Year-to-date operating income declined despite higher sales; expense increases, foreign exchange, price erosion, and acquisition/restructuring charges weighed on results.
- By segment, Q3 sales were $1.621B Transportation (up 2.2%), $806M Industrial (down 5.1%), and $691M Communications (up 8.0%). Segment operating income was $303M, $98M, and $68M, respectively. Communications growth reflected subsea project activity; weakness in data and devices and Industrial markets offset some gains.
Cash flow, liquidity, and capital
- Nine-month net cash from continuing operations was $1.079B, versus $1.142B; free cash flow, a company-defined non-GAAP measure, was $687M versus $901M. Higher inventory and timing of tax payments contributed to the decline. Capital expenditures were $425M.
- Cash and equivalents were $701M at June 26, down from $2.457B at fiscal year-end. Investing cash use was $2.165B, including $1.726B for acquisitions; financing cash use was $839M. The filing reports total debt of $4.026B, up from $3.858B. Current assets were $7.736B and current liabilities $4.041B.
- Cash returned to shareholders included $511M of share repurchases and $370M of dividends in the first nine months. The company had $3.3B remaining under its repurchase authorization. It reported compliance with debt covenants and no borrowings under its $1.5B revolving credit facility; $500M of floating-rate notes were due in January 2016.
Material developments, outlook, and risks
- TE Connectivity acquired Measurement Specialties in October 2014 for approximately $1.7B net of cash acquired; it contributed $143M of Q3 sales and $406M year to date. Goodwill increased to $4.841B, primarily reflecting acquisitions.
- The company agreed to sell Broadband Network Solutions for $3.0B cash, subject to a working-capital adjustment and customary approvals; closing was expected during calendar 2015. The business was reported as discontinued operations and held for sale.
- Q3 discontinued operations included a $126M pre-tax charge after a court verdict in the Com-Net case, concerning a former business sold in 2009. The company appealed. Consequently, total Q3 net income fell to $309M from $403M despite higher continuing-operations income. Year-to-date discontinued-operations income of $278M included tax benefits associated primarily with the anticipated BNS sale.
- Year-to-date tax expense was $85M versus $331M, reflecting a $202M benefit from effective settlement of certain 2001–2007 tax matters and other tax benefits. Related other expense included an $89M reduction in tax-sharing indemnification receivables.
- Management forecast Q4 FY2015 sales of $3.02B–$3.18B and continuing-operations diluted EPS of $0.81–$0.87. FY2015 guidance was sales of $12.28B–$12.42B and continuing-operations diluted EPS of $3.48–$3.54. Forecasts assumed current foreign-exchange rates and commodity prices; management estimated FX would reduce Q4 sales/EPS by about $244M/$0.10 and FY sales/EPS by about $925M/$0.32 versus FY2014.
- Management cited weakening conditions in China, continued oil-and-gas and commercial-transportation weakness, currency exposure (about 55% of sales invoiced in non-U.S. currencies), commodity-price fluctuations, pricing pressure, and execution risks from acquisitions and the planned BNS divestiture.
- Significant contingencies include disputed pre-separation tax matters with the IRS that could materially affect results, financial position, or cash flows if resolved adversely; the company stated it believed its reserves were appropriate. Environmental remediation was estimated at $17M–$38M, with a $20M best estimate. Outstanding letters of credit, guarantees, and surety bonds totaled $369M.
- Fiscal 2015 restructuring actions generated $65M of charges in the first nine months; management expected about $100M of charges for the year, approximately $105M of cash spending, and roughly $50M of annualized savings by the end of fiscal 2016.
Investor verification priorities
- Track whether BNS sale proceeds, timing, and final working-capital adjustment match the announced terms.
- Review progress on Q4 and full-year sales/EPS guidance, especially currency effects, China demand, and subsea project timing.
- Assess the Com-Net appeal and the remaining exposure from the disputed IRS intercompany-debt tax issue and related tax-sharing obligations.
- Monitor cash conversion, inventory levels, acquisition integration, debt maturities, and the planned restructuring savings against associated charges and cash costs.
- Separate recurring continuing-operations performance from discontinued-operation, tax-settlement, acquisition, and restructuring items when comparing earnings.