TE Connectivity Ltd. — Form 10-Q Summary
Business context and reporting period
Quarterly report for the three and six months ended March 28, 2014 (fiscal 2014 Q2), filed April 24, 2014. TE Connectivity designs and manufactures connectivity products across automotive, industrial, communications, consumer, healthcare, aerospace and other markets. Results are unaudited and stated in U.S. dollars; amounts below are in millions except per-share data.
The company reports four segments: Transportation Solutions, Industrial Solutions, Network Solutions and Consumer Solutions. Relay Products moved from Consumer to Industrial Solutions during fiscal 2014; prior segment comparisons were recast.
Financial performance
| Metric | Q2 FY2014 | Q2 FY2013 | Six months FY2014 | Six months FY2013 |
|---|---|---|---|---|
| Net sales | $3,431 | $3,265 | $6,757 | $6,399 |
| Gross margin | $1,173; 34.2% | $1,052; 32.2% | $2,290; 33.9% | $2,041; 31.9% |
| Operating income | $510 | $359 | $989 | $652 |
| Net income attributable to TE Connectivity | $362 | $277 | $715 | $554 |
| Diluted EPS | $0.87 | $0.65 | $1.71 | $1.30 |
| Operating cash flow | Not reported quarterly in this filing | $834 | $837 | |
| Free cash flow (non-GAAP) | Not reported quarterly in this filing | $539 | $657 |
Q2 reported sales rose 5.1% and organic sales rose 6.1%; six-month increases were 5.6% and 6.6%, respectively. Higher volume and manufacturing productivity, and to a lesser extent lower material costs, lifted gross margin; price erosion partly offset gains. Price erosion reduced organic sales by $62 million in Q2 and $123 million in the first half. Q2 operating margin was approximately 14.9%, compared with 11.0% a year earlier.
Six-month net income comparisons include significant tax-related items: FY2013 included a $331 million tax benefit from settled tax matters and $231 million of related other expense; FY2014 included a $263 million tax provision versus a $185 million tax benefit in FY2013. Q2 income tax expense was $136 million versus $60 million.
Segments and changes versus prior period
| Segment | Q2 sales | Q2 operating income | Q2 sales change |
|---|---|---|---|
| Transportation Solutions | $1,571 | $347 | +13.4%; organic +13.3% |
| Industrial Solutions | $789 | $106 | +4.1%; organic +4.4% |
| Network Solutions | $688 | $23 | -5.1%; organic -1.3% |
| Consumer Solutions | $383 | $34 | -3.5%; organic -2.9% |
Transportation led growth, with automotive sales increasing across all regions. Industrial growth reflected industrial equipment and aerospace/oil-and-gas demand. Network results were pressured by subsea project delays and weaker data communications; consumer devices weakness was partly offset by appliances. Segment operating income increased in each segment, though Network’s improvement reflected lower restructuring charges and underlying operating income excluding those charges declined.
Lower restructuring charges materially supported reported operating income: $21 million in Q2 and $28 million in the first half of FY2014, compared with $81 million and $173 million in the comparable FY2013 periods. SG&A rose to $471 million in Q2 and $938 million in the first half, mainly from selling and incentive costs; as a share of sales it increased to 13.7% and 13.9%, respectively.
Cash, debt and liquidity
- At March 28, 2014: cash $1,429; current assets $6,566; current liabilities $4,087; total debt $2,995, comprising $625 current maturities and $2,370 long-term debt. Total debt was $3,014 at September 27, 2013.
- First-half operating cash flow was $834, investing outflow $298, and financing outflow $500; cash increased $26 to $1,429. Continuing operating cash flow was $840 versus $839 in the prior-year period.
- Free cash flow, a company-defined non-GAAP measure, was $539 versus $657, primarily due to higher capital expenditures and changed tax-sharing cash flows. Capital expenditures were $301 versus $253.
- TEGSA had $375 of commercial paper outstanding at a weighted-average rate of 0.26%. A $1,500 revolving credit facility, expiring August 2018, was undrawn; the company reported compliance with its covenants.
- During the first half, the company repurchased about 7 million shares for $390 and paid $205 in dividends and distributions. Remaining repurchase authorization was approximately $1,088 at quarter-end.
Outlook, commentary and material risks
- FY2014 guidance: sales of $13.8–$14.1 billion and diluted EPS of $3.62–$3.74. Q3 guidance: sales of $3.54–$3.64 billion and diluted EPS of $0.93–$0.97. Outlook assumes foreign exchange rates and commodity prices remain near current levels.
- Management expected FY2014 Transportation sales growth of approximately 10%–12%, Industrial growth to a lesser degree, Network declines, and Consumer sales roughly flat. Subsea communications sales were expected to be approximately $300 million for FY2014.
- Management cited ongoing sensitivity to global economic conditions and end-market demand, pricing pressure, raw-material costs and availability, currency movements, customer and supplier conditions, competition, acquisitions, regulation and litigation.
- Restructuring: management expected approximately $50 million of net charges and $190 million of cash spending in FY2014. Annualized savings were estimated at $30 million for FY2014 actions by FY2016 and $115 million for FY2013 actions by FY2015.
- In April 2014, the company agreed to acquire SEACON Group for $490 million cash, subject to approvals and closing conditions; completion was expected during FY2014.
- Tax-sharing and IRS dispute: the company expects approximately $240 million in net cash payments for pre-separation tax matters over the next 12 months. A disputed IRS matter concerns intercompany debt and could materially affect results, financial position or cash flows if resolved adversely; the company said it believes its reserves are appropriate. Accrued interest and penalties on uncertain tax positions were $1,102 million.
- Environmental remediation costs were estimated at $14–$26 million, with a best estimate of $15 million. A $80 million maximum contingent purchase-price claim related to the Com-Net acquisition was not accrued because management did not consider payment probable. Outstanding letters of credit and guarantees totaled $336 million.
- Management reported no material changes to previously disclosed risk factors or market-risk exposures, and concluded disclosure controls were effective.
Important facts for investors to verify
- Whether sales growth and margin gains persist, particularly in automotive, and whether price erosion or weaker Network and Consumer markets intensify.
- Progress against FY2014 sales and EPS guidance, including the impact of foreign exchange, raw-material costs and restructuring.
- Cash conversion, capital spending, and the timing and size of the anticipated $240 million tax-related payments.
- Developments in the IRS intercompany-debt dispute, the related tax-sharing allocation, and adequacy of reserves.
- SEACON closing, purchase funding and integration, alongside continued share repurchases and dividend commitments.