TE Connectivity Ltd. (10-Q) — Fiscal 2016 First Quarter
Reporting period: Quarter ended December 25, 2015; comparative quarter ended December 26, 2014. The filing is for TE Connectivity Ltd. and reports in U.S. dollars. The company designs and manufactures connectivity and sensor solutions.
Key financial results
| Metric | Q1 FY2016 | Q1 FY2015 |
|---|---|---|
| Net sales | $2.833 billion | $3.049 billion |
| Gross margin | $945 million; 33.4% | $1.020 billion; 33.5% |
| Operating income / margin | $398 million; 14.0% | $425 million; 13.9% |
| Continuing income | $324 million | $435 million |
| Net income | $353 million | $472 million |
| Diluted EPS | $0.91 | $1.14 |
| Cash from operating activities | $366 million; continuing operations $367 million | $295 million; continuing operations $205 million |
| Free cash flow (non-GAAP) | $237 million | $79 million |
Net sales fell 7.1% year over year, including a 6.0% adverse currency-translation impact and a 1.8% organic decline; acquisitions contributed 0.7%. Gross margin percentage was nearly flat, while operating margin improved 0.1 percentage point. Prior-year results included unusual acquisition-related charges and tax items, so reported net income and EPS comparisons are not purely operational: Q1 FY2015 included a $189 million tax benefit and $83 million of other expense associated with tax settlements. Q1 FY2016 included a $38 million pre-tax gain on the BNS divestiture and a $28 million tax benefit related to the anticipated CPD sale.
Segments
| Segment | Sales, Q1 FY2016 | Sales change | Operating income, Q1 FY2016 | Operating income, prior year |
|---|---|---|---|---|
| Transportation Solutions | $1.507 billion | -6.5% reported; +0.9% organic | $261 million | $295 million |
| Industrial Solutions | $709 million | -9.6% reported; -6.3% organic | $66 million | $86 million |
| Communications Solutions | $617 million | -5.5% reported; -3.0% organic | $71 million | $44 million |
Transportation’s organic growth reflected automotive and sensors, partly offset by commercial transportation weakness. Industrial weakness centered on aerospace, defense, oil and gas, and industrial equipment. Communications declines in data and devices and appliances were partly offset by strong subsea communications sales.
Cash, liquidity, and debt
- Cash and cash equivalents were $2.223 billion at December 25, 2015, down from $3.329 billion at September 25, 2015. The quarter’s $1.106 billion net cash decrease was driven mainly by $1.249 billion of share repurchases.
- Total debt was $3.870 billion, including $500 million of current maturities and $3.370 billion of long-term debt. Cash exceeded current maturities; management said cash generation and available funding were expected to cover foreseeable capital needs.
- The company had a $1.5 billion undrawn revolving credit facility, extended to December 2020, and reported compliance with debt covenants. A $500 million floating-rate note maturity was due January 29, 2016.
- Capital expenditures were $139 million. The company expected FY2016 capital spending of approximately 5% of net sales.
- Share repurchases totaled $1.318 billion for approximately 20 million shares; $1.4 billion remained authorized. Dividends paid were $127 million, or $0.33 per share.
Material changes and notable items
- Foreign exchange was the principal cause of reported sales declines. Organic sales were down 1.8%; price erosion reduced organic sales by $53 million.
- Continuing operating cash flow rose $162 million year over year, primarily due to accounts-receivable collections; free cash flow increased to $237 million from $79 million.
- TE agreed to sell its Circuit Protection Devices business for $350 million cash, subject to working-capital adjustment and customary approvals. Closing was expected in Q2 FY2016. The business had approximately $200 million of net assets at quarter-end.
- The Broadband Network Solutions sale closed in FY2015 for $3.0 billion cash. TE recorded an additional $38 million pre-tax gain in Q1 FY2016, primarily from pension and working-capital adjustments.
- A new restructuring program affecting all segments recorded $32 million of charges in the quarter; estimated total charges for that program were approximately $65 million through FY2019. Management separately expected about $85 million of net restructuring charges and $95 million of cash spending in FY2016 across restructuring initiatives, with approximately $35 million of annualized savings expected by the end of FY2017.
Outlook, risks, and contingencies
- Q2 FY2016 guidance: Net sales of $2.88 billion to $3.08 billion and diluted EPS of $0.78 to $0.86. The outlook reflected market weakness, supply-chain inventory reductions, and estimated adverse foreign-exchange effects versus prior year of $73 million in sales and $0.03 per share.
- FY2016 guidance: Net sales of $11.9 billion to $12.7 billion and diluted EPS of $3.66 to $4.06. FY2016 has 53 weeks; the additional week was expected to contribute approximately $200 million in sales and $0.05 per share. Estimated adverse currency effects versus FY2015 were $344 million in sales and $0.13 per share.
- Management cited uncertain conditions in China, weaker industrial and oil-and-gas markets, inventory reductions, pricing pressure, currency movements, raw-material costs, customer and supplier conditions, and execution of acquisitions and divestitures as factors to monitor. Guidance assumed foreign-exchange rates and commodity prices remained near current levels.
- Tax dispute: After quarter-end, Tyco International entered conditional IRS settlement stipulations concerning intercompany debt tax disputes. If finalized, the total payment was expected to be $475 million to $525 million, including interest and penalties; TE’s expected share under the tax-sharing agreement was $147 million to $163 million, payable within six months. TE said existing reserves were sufficient and no additional charge was expected, but the settlement conditions and final application remained uncertain.
- A separate Com-Net lawsuit resulted in an October 2015 judgment of $127 million plus costs; TE said it was appropriately reserved and appealing. Environmental remediation costs were estimated at $16 million to $44 million, with a best estimate of $19 million. The company reported $504 million of letters of credit, guarantees, and bonds outstanding.
- Management did not expect ordinary-course legal claims or guarantees to have a material effect, but stated that the tax proceedings could materially affect results, financial position, or cash flows if resolved adversely. No material risk-factor changes were reported.
Important facts for investors to verify
- Whether the conditional IRS settlement was finalized, its final amount and allocation, and the timing of TE’s expected payment.
- Whether the CPD divestiture closed on the anticipated terms and how proceeds and the business exit affected Communications Solutions results.
- Whether sales, EPS, and currency assumptions tracked the Q2 and FY2016 guidance, particularly given China weakness and inventory reductions.
- Whether restructuring charges and cash spending remain within disclosed estimates and deliver the projected savings.
- How the large share repurchases, upcoming debt maturity, and cash balance affected liquidity after quarter-end.