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UNITED STATESSECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
FORM 10-Q
001-33260 (Commission File Number)
TE CONNECTIVITY LTD. (Exact name of registrant as specified in its charter)
Rheinstrasse 20CH-8200 Schaffhausen, Switzerland (Address of principal executive offices)
+41 (0)52 633 66 61 (Registrant's telephone number)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ý No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of "large accelerated filer," "accelerated filer," and "smaller reporting company" in Rule 12b-2 of the Exchange Act.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No ý
The number of common shares outstanding as of July 24, 2012 was 427,809,571.
TE CONNECTIVITY LTD. INDEX TO FORM 10-Q
Part I.
Financial Information
Item 1.
Financial Statements
Condensed Consolidated Statements of Operations for the Quarters and Nine Months Ended June 29, 2012 and June 24, 2011 (Unaudited)
Condensed Consolidated Balance Sheets as of June 29, 2012 and September 30, 2011 (Unaudited)
Condensed Consolidated Statements of Cash Flows for the Nine Months Ended June 29, 2012 and June 24, 2011 (Unaudited)
Notes to Condensed Consolidated Financial Statements (Unaudited)
Item 2.
Management's Discussion and Analysis of Financial Condition and Results of Operations
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
Item 4.
Controls and Procedures
Part II.
Other Information
Legal Proceedings
Item 1A.
Risk Factors
Unregistered Sales of Equity Securities and Use of Proceeds
Defaults Upon Senior Securities
Mine Safety Disclosures
Item 5.
Item 6.
Exhibits
Signatures
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
TE CONNECTIVITY LTD.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
Net sales
Cost of sales
Gross margin
Selling, general, and administrative expenses
Research, development, and engineering expenses
Acquisition and integration costs
Restructuring and other charges, net
Operating income
Interest income
Interest expense
Other income (expense), net
Income from continuing operations before income taxes
Income tax expense
Income from continuing operations
Income (loss) from discontinued operations, net of income taxes
Net income
Less: net income attributable to noncontrolling interests
Net income attributable to TE Connectivity Ltd.
Amounts attributable to TE Connectivity Ltd.:
Income (loss) from discontinued operations
Basic earnings per share attributable to TE Connectivity Ltd.:
Diluted earnings per share attributable to TE Connectivity Ltd.:
Dividends and cash distributions paid per common share of TE Connectivity Ltd.
Weighted-average number of shares outstanding:
Basic
Diluted
See Notes to Condensed Consolidated Financial Statements.
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CONDENSED CONSOLIDATED BALANCE SHEETS
Assets
Current Assets:
Cash and cash equivalents
Accounts receivable, net of allowance for doubtful accounts of $41 and $38, respectively
Inventories
Prepaid expenses and other current assets
Deferred income taxes
Assets held for sale
Total current assets
Property, plant, and equipment, net
Goodwill
Intangible assets, net
Receivable from Tyco International Ltd. and Covidien plc
Other assets
Total Assets
Liabilities and Equity
Current Liabilities:
Current maturities of long-term debt
Accounts payable
Accrued and other current liabilities
Deferred revenue
Liabilities held for sale
Total current liabilities
Long-term debt
Long-term pension and postretirement liabilities
Income taxes
Other liabilities
Total Liabilities
Commitments and contingencies (Note 11)
Equity:
TE Connectivity Ltd. Shareholders' Equity:
Common shares, 439,092,124 shares authorized and issued, CHF 1.17 par value, and 463,080,684 shares authorized and issued, CHF 1.37 par value, respectively
Contributed surplus
Accumulated earnings
Treasury shares, at cost, 11,318,310 and 39,303,550 shares, respectively
Accumulated other comprehensive income
Total TE Connectivity Ltd. shareholders' equity
Noncontrolling interests
Total Equity
Total Liabilities and Equity
2
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Cash Flows From Operating Activities:
(Income) loss from discontinued operations, net of income taxes
Adjustments to reconcile net cash provided by operating activities:
Depreciation and amortization
Provision for losses on accounts receivable and inventories
Share-based compensation expense
Other
Changes in assets and liabilities, net of the effects of acquisitions and divestitures:
Accounts receivable, net
Inventoried costs on long-term contracts
Net cash provided by continuing operating activities
Net cash provided by discontinued operating activities
Net cash provided by operating activities
Cash Flows From Investing Activities:
Capital expenditures
Proceeds from sale of property, plant, and equipment
Proceeds from sale of intangible assets
Proceeds from sale of short-term investments
Acquisition of business, net of cash acquired
Proceeds from divestiture of discontinued operations, net of cash retained by operations sold
Net cash used in continuing investing activities
Net cash used in discontinued investing activities
Net cash used in investing activities
Cash Flows From Financing Activities:
Net increase (decrease) in commercial paper
Proceeds from long-term debt
Repayment of long-term debt
Proceeds from exercise of share options
Repurchase of common shares
Payment of common share dividends and cash distributions to shareholders
Net cash provided by (used in) continuing financing activities
Net cash used in discontinued financing activities
Net cash provided by (used in) financing activities
Effect of currency translation on cash
Net increase (decrease) in cash and cash equivalents
Cash and cash equivalents at beginning of period
Cash and cash equivalents at end of period
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
1. Basis of Presentation
Basis of Presentation
The unaudited Condensed Consolidated Financial Statements of TE Connectivity Ltd. ("TE Connectivity" or the "Company," which may be referred to as "we," "us," or "our") have been prepared in United States Dollars, in accordance with accounting principles generally accepted in the United States of America ("GAAP"). The preparation of the Condensed Consolidated Financial Statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities, and the reported amounts of revenues and expenses. Actual results could differ materially from these estimates. In management's opinion, the unaudited Condensed Consolidated Financial Statements contain all normal recurring adjustments necessary for a fair presentation of interim results. The results of operations reported for interim periods are not necessarily indicative of the results of operations for the entire fiscal year or any subsequent interim period.
The Condensed Consolidated Financial Statements have been prepared in accordance with the instructions to Form 10-Q under the Securities Exchange Act of 1934, as amended. The year-end balance sheet data was derived from audited financial statements, but does not include all of the information and disclosures required by GAAP. These financial statements should be read in conjunction with our audited Consolidated Financial Statements contained in our Annual Report on Form 10-K for the fiscal year ended September 30, 2011.
Unless otherwise indicated, references in the Condensed Consolidated Financial Statements to fiscal 2012 and fiscal 2011 are to our fiscal years ending September 28, 2012 and September 30, 2011, respectively.
Reclassifications
We have reclassified certain items on our Condensed Consolidated Financial Statements to conform to the current year presentation.
2. Accounting Pronouncements
Recently Issued Accounting Pronouncements
In December 2011 and June 2011, the Financial Accounting Standards Board ("FASB") issued updates to guidance in Accounting Standards Codification ("ASC") 220, Comprehensive Income, that change the presentation and disclosure requirements of comprehensive income in interim and annual financial statements. These updates to ASC 220 are effective for us in the first quarter of fiscal 2013; however, we expect to early adopt these standards during the fourth quarter of fiscal 2012. Adoption is not expected to have a material impact on our Condensed Consolidated Financial Statements.
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)
3. Restructuring and Other Charges, Net
Charges (credits) to operations by segment were as follows:
Transportation Solutions
Communications and Industrial Solutions
Network Solutions
Restructuring and related charges, net
Amounts recognized on the Condensed Consolidated Statements of Operations were as follows:
Cash charges
Non-cash charges (credits)
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3. Restructuring and Other Charges, Net (Continued)
Restructuring and Related Cash Charges
Activity in our restructuring reserves during the first nine months of fiscal 2012 is summarized as follows:
Fiscal 2012 Actions:
Employee severance
Facilities exit costs
Total
Fiscal 2011 Actions:
Pre-Fiscal 2011 Actions:
Total Activity
Fiscal 2012 Actions
We initiated restructuring programs during fiscal 2012 associated with the acquisition of Deutsch Group SAS and related headcount reductions primarily in the Transportations Solutions segment as well as headcount reductions in the Communications and Industrial Solutions segment. In connection with these actions, during the nine months ended June 29, 2012, we recorded net restructuring charges of $86 million primarily related to employee severance and benefits. We expect to complete all restructuring activities commenced in fiscal 2012 by the end of fiscal 2013 and to incur total charges of approximately $87 million. Cash spending related to this plan was $30 million in the first nine months of fiscal 2012. We expect total cash spending to be approximately $59 million and $27 million in fiscal 2012 and 2013, respectively.
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The following table summarizes charges incurred for fiscal 2012 actions by segment:
Fiscal 2011 Actions
We initiated restructuring programs during fiscal 2011 which were primarily associated with the acquisition of ADC Telecommunications, Inc. ("ADC") and related headcount reductions in the Network Solutions segment. Additionally, we increased reductions in force as a result of economic conditions, primarily in the Communications and Industrial Solutions segment. In connection with these actions, during the nine months ended June 29, 2012 and June 24, 2011, we recorded net restructuring credits of $4 million and charges of $77 million, respectively, which primarily related to employee severance and benefits. We have completed all restructuring activities commenced in fiscal 2011. Cash spending related to this plan was $55 million in the first nine months of fiscal 2012. We expect total cash spending to be approximately $82 million and $20 million in fiscal 2012 and 2013, respectively.
The following table summarizes charges incurred for fiscal 2011 actions by segment:
Pre-Fiscal 2011 Actions
We initiated restructuring programs during fiscal 2010 primarily related to headcount reductions in the Transportation Solutions segment. During fiscal 2009, we initiated restructuring programs primarily related to headcount reductions and manufacturing site closures across all segments in response to economic conditions and the implementation of our manufacturing simplification plan. We have completed all restructuring activities commenced in fiscal 2010 and 2009. In connection with these pre-fiscal 2011 actions, during the nine months ended June 29, 2012 and June 24, 2011, we recorded net restructuring charges of $7 million and credits of $25 million, respectively. The credits in the first
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nine months of fiscal 2011 primarily related to decreases in planned employee headcount reductions associated with the Transportation Solutions segment.
During fiscal 2002, we recorded restructuring charges related to a significant downturn in the telecommunications industry and certain other end markets. These actions have been completed. As of June 29, 2012, the remaining restructuring reserves related to fiscal 2002 actions were $29 million, primarily associated with exited lease facilities in the Subsea Communications business in the Network Solutions segment. We expect that the remaining reserves will continue to be paid out over the expected terms of the obligations which range from one to fifteen years.
Cash spending related to pre-fiscal 2011 actions was $21 million in the first nine months of fiscal 2012, and we expect total cash spending of approximately $39 million and $15 million in fiscal 2012 and 2013, respectively.
Total Restructuring Reserves
Restructuring reserves by segment were as follows:
Restructuring reserves
Restructuring reserves were included on our Condensed Consolidated Balance Sheets as follows:
4. Acquisition
On April 3, 2012, we acquired 100% of the outstanding shares of Deutsch Group SAS ("Deutsch"). The total value paid for the transaction amounted to €1.55 billion (approximately $2.05 billion using an exchange rate of $1.33 per €1.00), net of cash acquired. The total value paid included $659 million related to the repayment of Deutsch's financial debt plus accrued interest. Deutsch is a global leader in high-performance connectors for harsh environments, and significantly expands our product portfolio and enables us to better serve customers in the industrial and commercial transportation, aerospace, defense, and marine, and rail markets. This acquisition is reported primarily as part of our Transportation Solutions segment from the date of acquisition.
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4. Acquisition (Continued)
The Deutsch acquisition was accounted for under the provisions of ASC 805, Business Combinations. We have preliminarily allocated the purchase price to tangible and identifiable intangible assets acquired and liabilities assumed based on their estimated fair values. We are in the process of completing the valuation of identifiable assets acquired and liabilities assumed and, therefore, the fair values set forth below are subject to adjustment upon finalizing the valuations. In addition, completion of the purchase price allocation may impact the net deferred tax liability of $187 million currently recognized with any adjustment resulting in a corresponding change to goodwill. The amount of these potential adjustments could be significant. We expect to complete the purchase price allocation during the current fiscal year.
The following table summarizes the preliminary allocation of the purchase price to the fair value of identifiable assets acquired and liabilities assumed at the date of acquisition, in accordance with the acquisition method of accounting:
Other current assets
Property, plant, and equipment
Intangible assets
Other long-term assets
Total assets acquired
Other current liabilities
Other long-term liabilities
Total liabilities assumed
Net assets acquired
Cash and cash equivalents acquired
Net cash paid
Other current assets primarily consist of inventories of $190 million and trade accounts receivable of $122 million. Other current liabilities assumed are primarily comprised of accrued and other current liabilities of $70 million and trade accounts payable of $56 million.
The fair values assigned to intangible assets were determined through the use of the income approach, specifically the relief from royalty method and the multi-period excess earnings method. Both valuation methods rely on management judgments, including expected future cash flows resulting from existing customer relationships, customer attrition rates, contributory effects of other assets utilized in the business, peer group cost of capital and royalty rates, and other factors. The valuation of tangible assets was derived using a combination of the income approach, the market approach, and the cost approach. Significant judgments used in valuing tangible assets include estimated reproduction or replacement cost, useful lives of assets, estimated selling prices, costs to complete, and reasonable
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profit. Useful lives for intangible assets were determined based upon the remaining useful economic lives of the intangible assets that are expected to contribute directly or indirectly to future cash flows.
Intangible assets acquired consist of the following:
Customer relationships
Developed technology
Trade names and trademarks
Customer order backlog
The acquired intangible assets are being amortized on a straight-line basis over their expected lives. The $1,026 million of goodwill is attributable to the excess of the purchase price over the fair value of the net tangible and intangible assets acquired and liabilities assumed. The goodwill recognized is primarily attributable to cost savings and other synergies that we expect to realize through operational efficiencies including consolidation of manufacturing, marketing, and general and administrative functions. Substantially all of the goodwill has been allocated to our Transportation Solutions segment and is not deductible for tax purposes. However, prior to its merger with us, Deutsch completed certain acquisitions that resulted in goodwill deductible primarily for U.S. tax purposes of approximately $215 million which we will deduct over the next thirteen years.
During the quarter ended June 29, 2012, Deutsch contributed net sales of $174 million and an operating loss of $62 million to our Condensed Consolidated Financial Statements. The operating loss included charges of $68 million associated with the amortization of acquisition-accounting related fair value adjustments primarily related to acquired inventories and customer order backlog, acquisition costs of $13 million, restructuring charges of $11 million, and integration costs of $2 million. During the nine months ended June 29, 2012, we incurred Deutsch-related acquisition and integration costs of $21 million and $2 million, respectively.
The following unaudited pro forma financial information reflects the consolidated results of operations of the Company had the Deutsch acquisition occurred at the beginning of fiscal 2011.
The pro forma financial information is based on our preliminary allocation of purchase price and therefore subject to adjustment upon finalizing the purchase price allocation. The significant pro forma adjustments which are described below are net of income tax expense (benefit) at the statutory rate.
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Pro forma results for the quarter ended June 29, 2012 were adjusted to exclude $30 million of charges related to the fair value adjustment to acquisition-date inventories, $12 million of charges related to acquired customer order backlog, $8 million of acquisition costs, and $2 million of charges related to other acquisition accounting-related adjustments. Pro forma results for the quarter ended June 29, 2012 were also adjusted to include $1 million of interest expense based on pro forma changes in our capital structure.
Pro forma results for the quarter ended June 24, 2011 were adjusted to exclude $11 million of interest expense based on pro forma changes in our capital structure, $7 million of income tax expense based on the estimated impact of combining Deutsch into our global tax position, and $1 million of charges related to depreciation expense. In addition, pro forma results for the quarter ended June 24, 2011 were adjusted to include $5 million of charges related to the amortization of the fair value of acquired intangible assets.
Pro forma results for the nine months ended June 29, 2012 were adjusted to exclude $30 million of interest expense based on pro forma changes in our capital structure, $30 million of charges related to the fair value adjustment to acquisition-date inventories, $20 million of income tax expense based on the estimated impact of combining Deutsch into our global tax position, $13 million of acquisition costs, $12 million of charges related to acquired customer order backlog, $2 million of share-based compensation expense incurred by Deutsch as a result of the change in control of Deutsch, $2 million of charges related to depreciation expense, and $2 million of charges related to other acquisition accounting-related adjustments. In addition, pro forma results for the nine months ended June 29, 2012 were adjusted to include $17 million of charges related to the amortization of the fair value of acquired intangible assets.
Pro forma results for the nine months ended June 24, 2011 were adjusted to exclude $32 million of interest expense based on pro forma changes in our capital structure, $20 million of income tax expense based on the estimated impact of combining Deutsch into our global tax position, and $3 million of charges related to depreciation expense. In addition, pro forma results for the nine months ended June 24, 2011 were adjusted to include $30 million of charges related to the fair value adjustment to acquisition-date inventories, $16 million of charges related to the amortization of the fair value of acquired intangible assets, $14 million of charges related to acquired customer order backlog, and $4 million of charges related to other acquisition accounting-related adjustments.
Pro forma results do not include any anticipated synergies or other anticipated benefits of the acquisition. Accordingly, the unaudited pro forma financial information is not necessarily indicative of either future results of operations or results that might have been achieved had the Deutsch acquisition occurred at the beginning of fiscal 2011.
5. Discontinued Operations
On June 1, 2012, we sold our Touch Solutions business for net cash proceeds of $380 million, subject to working capital adjustments, of which we received $370 million during the quarter ended June 29, 2012. We recognized an insignificant pre-tax loss on the transaction. The agreement includes contingent earn-out provisions through 2015 based on business performance. In connection with the divestiture, we incurred an income tax charge of $65 million, which is included in income (loss) from discontinued operations, net of income taxes on the Condensed Consolidated Statement of Operations
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5. Discontinued Operations (Continued)
for the quarter ended June 29, 2012, primarily as a result of being unable to realize a tax benefit from the write-off of goodwill at the time of the sale. We expect to make tax payments of approximately $10 million associated with this divestiture.
On April 27, 2012, we sold our TE Professional Services business for net cash proceeds of $29 million, of which we received $24 million during the quarter ended June 29, 2012, and recognized a pre-tax gain of $2 million on the transaction. In the second quarter of fiscal 2012, we recorded a pre-tax impairment charge of $28 million, which is included in income (loss) from discontinued operations, net of income taxes on the Condensed Consolidated Statement of Operations, to write the carrying value of the business down to its estimated fair value less costs to sell.
On December 27, 2011, the New York Court of Claims entered judgment in our favor in the amount of $25 million, payment of which was received in the second quarter of fiscal 2012, in connection with our former Wireless Systems business's State of New York contract. This judgment resolved all outstanding issues between the parties in this matter. This partial recovery of a previously recognized loss, net of legal fees, is reflected in income (loss) from discontinued operations, net of income taxes on the Condensed Consolidated Statement of Operations for the nine months ended June 29, 2012.
The Touch Solutions, TE Professional Services, and Wireless Systems businesses met the held for sale and discontinued operations criteria and have been included in discontinued operations in all periods presented. Prior to reclassification to discontinued operations, the Touch Solutions and TE Professional Services businesses were included in the Communications and Industrial Solutions and Network Solutions segments, respectively. The Wireless Systems business was a component of the former Wireless Systems segment.
The following table presents net sales, pre-tax income, pre-tax gain (loss) on sale, and income tax expense from discontinued operations:
Pre-tax income from discontinued operations
Pre-tax gain (loss) on sale of discontinued operations
12
The following table presents balance sheet information for assets and liabilities held for sale at fiscal year end 2011. There were no such amounts at June 29, 2012:
Total assets
Total liabilities
6. Inventories
Inventories consisted of the following:
Raw materials
Work in progress
Finished goods
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7. Goodwill
The changes in the carrying amount of goodwill by segment were as follows:
Balance at September 30, 2011:
Accumulated impairment losses
Goodwill, net of impairment losses
Changes in goodwill:
Acquisition
Currency translation
Balance at June 29, 2012:
During the third quarter of fiscal 2012, we completed the acquisition of Deutsch and recognized $1,026 million of goodwill, which primarily benefits the Transportation Solutions segment. See Note 4 for additional information on the acquisition of Deutsch.
8. Intangible Assets, Net
Intangible assets were as follows:
Intellectual property
During the quarter ended June 29, 2012, the Deutsch acquisition increased the gross carrying amount of intangible assets by $837 million. Intangible asset amortization expense was $47 million and $16 million for the quarters ended June 29, 2012 and June 24, 2011, respectively, and $76 million and $49 million for the nine months ended June 29, 2012 and June 24, 2011 respectively.
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8. Intangible Assets, Net (Continued)
The estimated aggregate amortization expense on intangible assets is expected to be as follows:
Remainder of fiscal 2012
Fiscal 2013
Fiscal 2014
Fiscal 2015
Fiscal 2016
Fiscal 2017
Thereafter
9. Debt
Debt was as follows:
6.00% senior notes due 2012
5.95% senior notes due 2014
1.60% senior notes due 2015
6.55% senior notes due 2017
4.875% senior notes due 2021
3.50% senior notes due 2022
7.125% senior notes due 2037
3.50% convertible subordinated notes due 2015
Commercial paper, at a weighted-average interest rate of 0.43% at June 29, 2012
Total debt(1)
Less current maturities of long-term debt(2)
During February 2012, Tyco Electronics Group S.A. ("TEGSA"), our wholly-owned subsidiary, issued $250 million aggregate principal amount of 1.60% senior notes due February 3, 2015 and $500 million aggregate principal amount of 3.50% senior notes due February 3, 2022. The notes were offered and sold pursuant to an effective registration statement on Form S-3 filed on January 21, 2011. Interest on the notes is payable semi-annually on February 3 and August 3 of each year, beginning
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9. Debt (Continued)
August 3, 2012. The notes are TEGSA's unsecured senior obligations and rank equally in right of payment with all existing and any future senior indebtedness of TEGSA and senior to any subordinated indebtedness that TEGSA may incur. Net proceeds from the issuance of the notes due 2015 and 2022, were approximately $250 million and $498 million, respectively. In connection with the issuance of the senior notes in February 2012, the commitments of the lenders under the $700 million 364-day credit agreement, dated as of December 20, 2011, automatically terminated.
In June 2011, TEGSA entered into a five-year unsecured senior revolving credit facility ("Credit Facility"), with total commitments of $1,500 million. TEGSA had no borrowings under the Credit Facility at June 29, 2012 and September 30, 2011.
The Credit Facility contains a financial ratio covenant providing that if, as of the last day of each fiscal quarter, our ratio of Consolidated Total Debt (as defined in the Credit Facility) to Consolidated EBITDA (as defined in the Credit Facility) for the then most recently concluded period of four consecutive fiscal quarters exceeds 3.5 to 1.0, an Event of Default (as defined in the Credit Facility) is triggered. The Credit Facility and our other debt agreements contain other customary covenants.
TEGSA's payment obligations under its senior notes, commercial paper, and Credit Facility are fully and unconditionally guaranteed by TE Connectivity Ltd. Neither TE Connectivity Ltd. nor any of its subsidiaries provides a guarantee as to payment obligations under the 3.50% convertible subordinated notes due 2015 and other notes issued by ADC prior to its acquisition in December 2010.
We have used, and continue to use, derivative instruments to manage interest rate risk. See Note 12 for information on options to enter into interest rate swaps ("swaptions"), forward starting interest rate swaps, and interest rate swaps.
The fair value of our debt, based on indicative valuations, was approximately $4,078 million and $2,968 million at June 29, 2012 and September 30, 2011, respectively.
10. Guarantees
Pursuant to the Separation and Distribution Agreement and Tax Sharing Agreement, upon separation from Tyco International Ltd. ("Tyco International") on June 29, 2007, we entered into certain guarantee commitments and indemnifications with Tyco International and Covidien plc ("Covidien"). Under these agreements, principally the Tax Sharing Agreement, we, Tyco International, and Covidien share 31%, 27%, and 42%, respectively, of certain contingent liabilities relating to unresolved pre-separation tax matters of Tyco International. The effect of the Tax Sharing Agreement is to indemnify us for 69% of certain liabilities settled in cash by us with respect to unresolved pre-separation tax matters. Pursuant to that indemnification, we have made similar indemnifications to Tyco International and Covidien with respect to 31% of certain liabilities settled in cash by the companies relating to unresolved pre-separation tax matters. If any of the companies responsible for all or a portion of such liabilities were to default in its payment of costs or expenses related to any such liability, we would be responsible for a portion of the defaulting party or parties' obligation. In addition, Tyco International and Covidien are responsible for their tax liabilities that are not subject to the Tax Sharing Agreement's sharing formula. Our indemnification created under the Tax Sharing Agreement qualifies as a guarantee of a third party entity's debt under ASC 460, Guarantees.
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10. Guarantees (Continued)
At June 29, 2012, we had a liability representing the indemnifications made to Tyco International and Covidien pursuant to the Tax Sharing Agreement of $239 million of which $225 million was reflected in other liabilities and $14 million was reflected in accrued and other current liabilities on the Condensed Consolidated Balance Sheet. At September 30, 2011, the liability was $249 million and consisted of $228 million in other liabilities and $21 million in accrued and other current liabilities. The amount reflected in accrued and other current liabilities is our estimated cash obligation under the Tax Sharing Agreement to Tyco International and Covidien in connection with pre-separation tax matters that could be resolved within the next twelve months.
We have assessed the probable future cash payments to Tyco International and Covidien for pre-separation income tax matters pursuant to the terms of the Tax Sharing Agreement and determined that $239 million remains sufficient to satisfy these expected obligations.
In disposing of assets or businesses, we often provide representations, warranties, and/or indemnities to cover various risks including unknown damage to assets, environmental risks involved in the sale of real estate, liability for investigation and remediation of environmental contamination at waste disposal sites and manufacturing facilities, and unidentified tax liabilities and legal fees related to periods prior to disposition. We have no reason to believe that these uncertainties would have a material adverse effect on our results of operations, financial position, or cash flows.
At June 29, 2012, we had outstanding letters of credit and letters of guarantee in the amount of $349 million.
In the normal course of business, we are liable for contract completion and product performance. In the opinion of management, such obligations will not significantly affect our results of operations, financial position, or cash flows.
We generally record estimated product warranty costs when contract revenues are recognized under the percentage-of-completion method for construction related contracts and at the time of sale for products. The estimation is primarily based on historical experience and actual warranty claims. Amounts accrued for warranty claims at June 29, 2012 and September 30, 2011 were $51 million and $54 million, respectively.
11. Commitments and Contingencies
TE Connectivity Legal Proceedings
In the ordinary course of business, we are subject to various legal proceedings and claims, including patent infringement claims, product liability matters, employment disputes, disputes on agreements, other commercial disputes, environmental matters, antitrust claims, and tax matters, including non-income tax matters such as value added tax, sales and use tax, real estate tax, and transfer tax. Although it is not feasible to predict the outcome of these proceedings, based upon our experience, current information, and applicable law, we do not expect that the outcome of these proceedings, either individually or in the aggregate, will have a material effect on our results of operations, financial position, or cash flows.
At June 29, 2012, we had a contingent purchase price commitment of $80 million related to our fiscal 2001 acquisition of Com-Net. This represents the maximum amount payable to the former
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11. Commitments and Contingencies (Continued)
shareholders of Com-Net only after the construction and installation of a communications system for the State of Florida was completed and approved by the State of Florida in accordance with guidelines set forth in the contract. Under the terms of the purchase and sale agreement, we do not believe we have any obligation to the sellers. However, the sellers have contested our position and initiated a lawsuit in June 2006 in the Court of Common Pleas in Allegheny County, Pennsylvania, which is in the discovery phase. A liability for this contingency has not been recorded on the Condensed Consolidated Financial Statements as we do not believe that any payment is probable or reasonably estimable at this time.
Legal Matters under Separation and Distribution Agreement
The Separation and Distribution Agreement among us, Tyco International, and Covidien provided for the allocation among the parties of Tyco International's assets, liabilities, and obligations attributable to periods prior to our and Covidien's separations from Tyco International on June 29, 2007. Under the Separation and Distribution Agreement, we assumed the liability for, and control of, all pending and threatened legal matters at separation related to our business or assumed or retained liabilities. We were responsible for 31% of certain liabilities that arose from litigation pending or threatened at separation that was not allocated to one of the three parties, and Tyco International and Covidien were responsible for 27% and 42%, respectively, of such liabilities. If any party defaults in payment of its allocated share of any such liability, each non-defaulting party will be responsible for an equal portion of the amount in default together with any other non-defaulting party, although any such payments will not release the obligation of the defaulting party. Subject to the terms and conditions of the Separation and Distribution Agreement, Tyco International manages and controls all the legal matters related to the shared contingent liabilities, including the defense or settlement thereof, subject to certain limitations. All costs and expenses that Tyco International incurs in connection with the defense of such litigation, other than the amount of any judgment or settlement, which is allocated in the manner described above, will be borne equally by Tyco International, Covidien, and us. At the present time, all significant matters for which we shared responsibility with Tyco International and Covidien under the Separation and Distribution Agreement, which as previously reported in our periodic filings generally related to securities class action cases and other securities cases, have been settled. Other than matters described below under "Compliance Matters," we presently are not aware of any additional legal matters which may arise for which we would bear a portion of the responsibility under the Separation and Distribution Agreement.
Compliance Matters
As previously reported in our periodic filings, Tyco International received and has responded to various allegations that certain improper payments were made by Tyco International subsidiaries, including our subsidiaries, in recent years prior to the separation. Tyco International reported to the U.S. Department of Justice and the Securities and Exchange Commission the investigative steps and remedial measures that it had taken in response to the allegations, including that it retained outside counsel to perform a company-wide baseline review of its policies, controls, and practices with respect to compliance with the Foreign Corrupt Practices Act ("FCPA"), and that it would continue to investigate and make periodic progress reports to these agencies. To date, our baseline review has revealed that some of our former business practices may not have complied with FCPA requirements.
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At this time, we believe we have adequate amounts recorded related to these matters, the amounts of which are not significant. Any judgment, settlement, or other cost incurred by Tyco International in connection with these matters not specifically allocated to Tyco International, Covidien, or us would be subject to the liability sharing provisions of the Separation and Distribution Agreement.
Income Taxes
In prior years, in connection with the Internal Revenue Service ("IRS") audit of various fiscal years, Tyco International submitted to the IRS proposed adjustments to prior period U.S. federal income tax returns resulting in a reduction in the taxable income previously filed. The IRS accepted substantially all of the proposed adjustments for fiscal 1997 through 2000 for which the IRS had completed its field work. On the basis of previously accepted amendments, we have determined that acceptance of adjustments presented for additional periods through fiscal 2006 is more likely than not to be accepted and, accordingly, have recorded them, as well as the impacts of the adjustments accepted by the IRS, on the Condensed Consolidated Financial Statements.
As our tax return positions continue to be updated for periods prior to separation, additional adjustments may be identified and recorded on the Condensed Consolidated Financial Statements. While the final adjustments cannot be determined until the income tax return amendment process is completed and accepted by the IRS, we believe that any resulting adjustments will not have a material impact on our results of operations, financial position, or cash flows. Additionally, adjustments may be recorded to equity in the future for the impact of filing final or amended income tax returns in certain jurisdictions where those returns include a combination of Tyco International, Covidien, and/or our subsidiaries for the periods prior to the separation.
During fiscal 2007, the IRS concluded its field examination of certain of Tyco International's U.S. federal income tax returns for the years 1997 through 2000 and issued Revenue Agent Reports which reflect the IRS' determination of proposed tax adjustments for the 1997 through 2000 period. Tyco International has appealed certain proposed adjustments totaling approximately $1 billion. Additionally, the IRS proposed civil fraud penalties against Tyco International arising from alleged actions of former executives in connection with certain intercompany transfers of stock in 1998 and 1999. Based upon statutory guidelines, Tyco International estimates the proposed penalties could range between $30 million and $50 million. The penalty is asserted against a prior subsidiary of Tyco International that was distributed to us in connection with the separation. Any penalty ultimately imposed upon our subsidiary would be subject to sharing with Tyco International and Covidien under the Tax Sharing Agreement. It is our understanding that Tyco International continues to make progress towards resolving a substantial number of proposed tax adjustments for the years 1997 through 2000; however, several significant matters remain in dispute. The remaining issues in dispute involve the tax treatment of certain intercompany debt transactions. Tyco International has indicated that it is unlikely to achieve the resolution of these contested adjustments through the IRS appeals process, and therefore may be required to litigate the disputed issues. In the first nine months of fiscal 2012, we made payments of $70 million for tax deficiencies related to undisputed tax adjustments for the years 1997 through 2000. Concurrent with remitting these payments, we were reimbursed $44 million from Tyco International and Covidien pursuant to their indemnifications for pre-separation tax matters. For those issues not in dispute, we expect the IRS to complete its examination for the years 1997 through 2000 and issue special agreement Forms 870-AD by early fiscal 2013. Over the next twelve months, we expect to pay
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approximately $26 million, inclusive of related indemnification payments, in connection with these pre-separation tax matters.
During fiscal 2011, the IRS completed its field examination of certain Tyco International income tax returns for the years 2001 through 2004, issued Revenue Agent Reports which reflect the IRS' determination of proposed tax adjustments for the 2001 through 2004 period, and issued certain notices of deficiency. As a result of the completion of fieldwork and the settlement of certain tax matters, in the third quarter of fiscal 2011, we recognized income tax benefits of $35 million and other expense of $14 million pursuant to the Tax Sharing Agreement. Also, in the fourth quarter of fiscal 2011, we made net cash payments of $154 million related to pre-separation deficiencies.
The IRS commenced its audit of certain Tyco International income tax returns for the years 2005 through 2007 in fiscal 2011.
During the third quarter of fiscal 2012, the IRS commenced its audit of our income tax returns for the years 2008 through 2010.
At June 29, 2012 and September 30, 2011, we have reflected $74 million and $232 million, respectively, of income tax liabilities related to the audits of Tyco International's and our income tax returns in accrued and other current liabilities as certain of these matters could be resolved within the next twelve months.
We continue to believe that the amounts recorded on our Condensed Consolidated Financial Statements relating to the matters discussed above are appropriate. However, the ultimate resolution is uncertain and could result in a material impact to our results of operations, financial position, or cash flows.
Environmental Matters
We are involved in various stages of investigation and cleanup related to environmental remediation matters at a number of sites. The ultimate cost of site cleanup is difficult to predict given the uncertainties regarding the extent of the required cleanup, the interpretation of applicable laws and regulations, and alternative cleanup methods. As of June 29, 2012, we concluded that it was probable that we would incur remedial costs in the range of $13 million to $26 million. As of June 29, 2012, we concluded that the best estimate within this range is $13 million, of which $9 million is included in accrued and other current liabilities and $4 million is included in other liabilities on the Condensed Consolidated Balance Sheet. In view of our financial position and reserves for environmental matters of $13 million, we believe that any potential payment of such estimated amounts will not have a material adverse effect on our results of operations, financial position, or cash flows.
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12. Financial Instruments
We use derivative and non-derivative financial instruments to manage certain exposures to foreign currency, interest rate, investment, and commodity risks.
Foreign Exchange Risks
As part of managing the exposure to changes in foreign currency exchange rates, we utilize foreign currency forward and swap contracts, a portion of which are designated as cash flow hedges. The objective of these contracts is to minimize impacts to cash flows and profitability due to changes in foreign currency exchange rates on intercompany transactions, accounts receivable, accounts payable, and other cash transactions.
We expect that significantly all of the balance in accumulated other comprehensive income associated with the cash flow hedge-designated instruments addressing foreign exchange risks will be reclassified into the Condensed Consolidated Statements of Operations within the next twelve months.
Interest Rate and Investment Risk Management
We issue debt, from time to time, to fund our operations and capital needs. Such borrowings can result in interest rate exposure. To manage the interest rate exposure, we use interest rate swaps to convert a portion of fixed-rate debt into variable-rate debt. We use forward starting interest rate swaps and swaptions to manage interest rate exposure in periods prior to the anticipated issuance of fixed-rate debt. We also utilize interest rate and investment swap contracts to manage interest rate and earnings exposure on certain non-qualified deferred compensation liabilities.
During the first nine months of fiscal 2012, in conjunction with the issuance of the 1.60% senior notes due 2015 and 3.50% senior notes due 2022, we terminated forward starting interest rate swaps and swaptions designated as cash flow hedges on notional amounts of $400 million for a cash payment of $24 million. The effective portion of the forward starting interest rate swaps, approximately $24 million, was recorded in accumulated other comprehensive income and is reclassified to interest expense over a four year period. The ineffective portion of the forward starting interest rate swaps and the remaining unamortized premium of the swaptions were insignificant and were recorded in interest expense during the second quarter of fiscal 2012. Also during the first nine months of fiscal 2012 and in conjunction with the debt issuance (see Note 9 for additional information regarding the debt issuance), we entered into, and subsequently terminated, a cash flow hedge-designated interest rate swap on a notional amount of $300 million of the 3.50% senior notes due 2022 for a cash payment of $2 million. That cash payment was recorded in accumulated other comprehensive income and is reclassified to interest expense over a ten year period.
Commodity Hedges
As part of managing the exposure to certain commodity price fluctuations, we utilize commodity swap contracts designated as cash flow hedges. The objective of these contracts is to minimize impacts to cash flows and profitability due to changes in prices of commodities used in production.
At June 29, 2012 and September 30, 2011, our commodity hedges had notional values of $214 million and $211 million, respectively. We expect that significantly all of the balance in
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12. Financial Instruments (Continued)
accumulated other comprehensive income associated with the commodities hedges will be reclassified into the Condensed Consolidated Statements of Operations within the next twelve months.
Hedges of Net Investment
We hedge our net investment in certain foreign operations using intercompany non-derivative financial instruments denominated in the same currencies. The aggregate notional value of these hedges was $1,739 million and $1,542 million at June 29, 2012 and September 30, 2011, respectively. We recorded foreign exchange gains of $20 million and losses of $4 million during the quarters ended June 29, 2012 and June 24, 2011, respectively, and gains of $80 million and losses of $106 million during the nine months ended June 29, 2012 and June 24, 2011, respectively, to currency translation, a component of accumulated other comprehensive income, offsetting foreign exchange gains or losses attributable to the translation of the net investment. See additional information in Note 19.
Derivative Instrument Summary
The fair value of our derivative instruments is summarized below.
Derivatives designated as hedging instruments:
Foreign currency contracts(3)
Interest rate swaps and swaptions
Commodity swap contracts
Total derivatives designated as hedging instruments
Derivatives not designated as hedging instruments:
Investment swaps
Total derivatives not designated as hedging instruments
Total derivatives
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in accrued and other current liabilities on the Condensed Consolidated Balance Sheets totaled $27 million and $43 million at June 29, 2012 and September 30, 2011, respectively. Interest rate swaps and swaptions and commodity swap contracts in liability positions that mature more than one year from the balance sheet date are recorded in other liabilities on the Condensed Consolidated Balance Sheets and totaled $2 million at June 29, 2012; there were no derivatives in other liabilities at September 30, 2011.
The effects of derivative instruments designated as fair value hedges on the Condensed Consolidated Statements of Operations were as follows:
Interest rate swaps(1)
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The effects of derivative instruments designated as cash flow hedges on the Condensed Consolidated Statements of Operations for the quarters ended were as follows:
For the Quarter Ended June 29, 2012:
Foreign currency contracts
Interest rate swaps and swaptions(1)
For the Quarter Ended June 24, 2011:
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The effects of derivative instruments designated as cash flow hedges on the Condensed Consolidated Statements of Operations for the nine months ended were as follows:
For the Nine Months Ended June 29, 2012:
For the Nine Months Ended June 24, 2011:
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The effects of derivative instruments not designated as hedging instruments on the Condensed Consolidated Statements of Operations were as follows:
During the quarter and nine months ended June 29, 2012, we incurred losses of $15 million and $36 million, respectively, as a result of marking foreign currency derivatives not designated as hedging instruments to fair value. The losses were offset by gains realized as a result of re-measuring certain non-U.S. Dollar-denominated intercompany non-derivative financial instruments to the U.S. Dollar and included, during the first six months of fiscal 2012, losses of $20 million incurred in anticipation of the acquisition of Deutsch.
13. Fair Value Measurements
Guidance on fair value measurement in ASC 820, Fair Value Measurements and Disclosures, specifies a fair value hierarchy based upon the observable inputs utilized in valuation of certain assets and liabilities. Observable inputs (highest level) reflect market data obtained from independent sources, while unobservable inputs (lowest level) reflect internally developed market assumptions. Fair value measurements are classified under the following hierarchy:
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13. Fair Value Measurements (Continued)
Financial assets and liabilities recorded at fair value on a recurring basis were as follows:
June 29, 2012:
Assets:
Foreign currency contracts(1)
Rabbi trust assets
Total assets at fair value
Liabilities:
Investment swap contracts
Total liabilities at fair value
September 30, 2011:
The following is a description of the valuation methodologies used for the respective financial assets and liabilities measured at fair value on a recurring basis:
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The majority of derivatives that we enter into are valued using the over-the-counter quoted market prices for similar instruments. We do not believe that fair values of these derivative instruments materially differ from the amounts that could be realized upon settlement or maturity.
Other Financial Instruments
Financial instruments other than derivative instruments include cash and cash equivalents, accounts receivable, accounts payable and long-term debt. These instruments are recorded on our Condensed Consolidated Balance Sheets at book value, which we believe approximates fair value (see Note 9 for disclosure of the fair value of long-term debt). The following is a description of the valuation methodologies used for the respective financial instruments:
As of June 29, 2012, we did not have significant financial assets or liabilities that were measured at fair value on a non-recurring basis.
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During the first nine months of fiscal 2012, we used significant other observable inputs (level 2) to calculate an impairment charge related to the TE Professional Services business. See Note 5 for additional information.
14. Retirement Plans
The net periodic benefit cost for all U.S. and non-U.S. defined benefit pension plans for the quarters ended was as follows:
Service cost
Interest cost
Expected return on plan assets
Amortization of prior service credit
Amortization of net actuarial loss
Net periodic benefit pension cost
The net periodic benefit cost for all U.S. and non-U.S. defined benefit pension plans for the nine months ended was as follows:
The net periodic benefit cost for postretirement benefit plans was insignificant for the quarters and nine months ended June 29, 2012 and June 24, 2011.
We anticipate that, at a minimum, we will make the minimum required contributions to our pension plans in fiscal 2012 of $3 million for U.S. plans and $97 million for non-U.S. plans. During the nine months ended June 29, 2012, we contributed $1 million to our U.S. plans and $72 million to our non-U.S. plans.
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14. Retirement Plans (Continued)
We anticipate that we will make contributions to our postretirement benefit plans of $2 million in fiscal 2012. During the nine months ended June 29, 2012, contributions to our postretirement benefit plans were insignificant.
15. Income Taxes
We recorded a tax provision of $88 million, for an effective income tax rate of 25.3%, and a tax provision of $70 million, for an effective income tax rate of 16.6%, for the quarters ended June 29, 2012 and June 24, 2011, respectively. The effective income tax rate for the quarter ended June 29, 2012 reflects income tax benefits recognized in connection with expected increased profitability in fiscal 2012 in certain entities operating in lower tax rate jurisdictions, offset by the estimated tax impacts of certain intercompany dividends. In addition, the effective income tax rate for the quarter ended June 29, 2012 reflects tax benefits recognized in connection with the finalization of prior year's tax returns, as well as accruals of interest related to uncertain tax positions. The effective income tax rate for the quarter ended June 24, 2011 reflects income tax benefits recognized in connection with expected increased profitability in fiscal 2011 in certain entities operating in lower tax rate jurisdictions and benefits of $35 million associated with the completion of fieldwork and the settlement of certain U.S. tax matters, partially offset by accruals of interest related to uncertain tax positions.
We recorded a tax provision of $267 million, for an effective income tax rate of 25.8%, and a tax provision of $247 million, for an effective income tax rate of 21.4%, for the nine months ended June 29, 2012 and June 24, 2011, respectively. The effective income tax rate for the nine months ended June 29, 2012 reflects income tax benefits recognized in connection with expected increased profitability in fiscal 2012 in certain entities operating in lower tax rate jurisdictions. These benefits were partially offset by accruals of interest related to uncertain tax positions and income tax expense associated with certain non-U.S. tax rate changes enacted in the quarter ended December 30, 2011. The effective income tax rate for the nine months ended June 24, 2011 reflects income tax benefits recognized in connection with expected increased profitability in fiscal 2011 in certain entities operating in lower tax rate jurisdictions partially offset by accruals of interest related to uncertain tax positions. The effective income tax rate for the nine months ended June 24, 2011 also reflects income tax benefits of $35 million associated with the completion of fieldwork and the settlement of certain U.S. tax matters.
We record accrued interest as well as penalties related to uncertain tax positions as part of the provision for income taxes. As of June 29, 2012, we had recorded $1,303 million of accrued interest and penalties related to uncertain tax positions on the Condensed Consolidated Balance Sheet, of which $1,267 million was recorded in income taxes and $36 million was recorded in accrued and other current liabilities. During the quarter and nine months ended June 29, 2012, we recognized $13 million and $63 million, respectively, of expense related to interest and penalties on the Condensed Consolidated Statements of Operations. As of September 30, 2011, the balance of accrued interest and penalties was $1,287 million, of which $1,154 million was recorded in income taxes and $133 million was recorded in accrued and other current liabilities on the Condensed Consolidated Balance Sheet.
During fiscal 2007, the IRS concluded its field examination of certain of Tyco International's U.S. federal income tax returns for the years 1997 through 2000. Tyco International is in the process of appealing certain tax adjustments proposed by the IRS related to this period. During fiscal 2011, the IRS completed its field examination of certain Tyco International income tax returns for the years 2001
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15. Income Taxes (Continued)
through 2004 and issued Revenue Agent Reports which reflect the IRS' determination of proposed tax adjustments for the 2001 through 2004 period. Also, during fiscal 2011, the IRS commenced its audit of certain Tyco International income tax returns for the years 2005 through 2007. During the third quarter of fiscal 2012, the IRS commenced its audit of our income tax returns for the years 2008 through 2010. See Note 11 for additional information regarding the status of IRS examinations.
Although it is difficult to predict the timing or results of certain pending examinations, it is our understanding that Tyco International continues to make progress towards resolving a substantial number of proposed tax adjustments for the years 1997 through 2000; however, several significant matters remain in dispute. The remaining issues in dispute involve the tax treatment of certain intercompany debt transactions. Tyco International has indicated that it is unlikely to achieve the resolution of these contested adjustments through the IRS appeals process, and therefore may be required to litigate the disputed issues. For those issues not in dispute, we expect the IRS to complete its examination for the years 1997 through 2000 and issue special agreement Forms 870-AD by early fiscal 2013. While the ultimate resolution is uncertain, based upon the current status of these examinations, we estimate that up to approximately $200 million of unrecognized income tax benefits, excluding the impacts relating to accrued interest and penalties, could be resolved within the next twelve months.
We are not aware of any other matters that would result in significant changes to the amount of unrecognized income tax benefits reflected on the Condensed Consolidated Balance Sheet as of June 29, 2012.
16. Other Income, Net
We recorded net other income of $19 million and net other expense of $5 million in the quarters ended June 29, 2012 and June 24, 2011, respectively, and net other income of $31 million and $13 million in the nine months ended June 29, 2012 and June 24, 2011, respectively, primarily consisting of income pursuant to the Tax Sharing Agreement with Tyco International and Covidien. During the third quarter of fiscal 2011, we recorded other expense of $14 million in connection with the completion of fieldwork and the settlement of certain U.S. tax matters. See additional information in Note 11.
17. Earnings Per Share
Basic earnings per share is computed by dividing net income attributable to TE Connectivity Ltd. by the basic weighted-average number of common shares outstanding. Diluted earnings per share is computed by dividing net income attributable to TE Connectivity Ltd. by the weighted-average number of common shares outstanding adjusted for potentially dilutive unexercised share options and
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17. Earnings Per Share (Continued)
non-vested restricted share awards. The following table sets forth the denominators of the basic and diluted earnings per share computations:
Weighted-average shares outstanding:
Dilutive share options and restricted share awards
Certain share options were not included in the computation of diluted earnings per share because the instruments' underlying exercise prices were greater than the average market prices of our common shares and inclusion would be antidilutive. Such shares not included in the computation were 14 million and 9 million for the quarters ended June 29, 2012 and June 24, 2011, respectively, and 12 million for each of the nine months ended June 29, 2012 and June 24, 2011.
18. Equity
Common Shares
Subject to certain conditions specified in the articles of association, we are authorized to increase our share capital by issuing new shares in aggregate not exceeding 50% of our authorized shares. Additionally, in March 2011, our shareholders reapproved and extended through March 9, 2013 our board of directors' authorization to issue additional new shares, subject to certain conditions specified in the articles, in aggregate not exceeding 50% of the amount of our authorized shares. Although we state our par value in Swiss Francs ("CHF"), we continue to use the U.S. Dollar as our reporting currency for preparing our Condensed Consolidated Financial Statements.
Common Shares Held in Treasury
At June 29, 2012, approximately 11 million common shares were held in treasury, all of which were owned by one of our subsidiaries. At September 30, 2011, approximately 39 million common shares were held in treasury, of which 15 million were owned by one of our subsidiaries. Shares held both directly by us and by our subsidiary are presented as treasury shares on the Condensed Consolidated Balance Sheets.
In March 2012, our shareholders approved the cancellation of 23,988,560 shares purchased under our share repurchase program during the period from December 25, 2010 to December 30, 2011. The capital reduction by cancellation of shares was subject to a notice period and filing with the commercial register and became effective in May 2012. As a result of the cancellation of shares, common shares, contributed surplus, and treasury shares on the Condensed Consolidated Balance Sheets decreased by $11 million, $790 million, and $801 million, respectively.
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18. Equity (Continued)
Contributed Surplus
Contributed surplus originally established during the Change of Domicile for Swiss tax and statutory purposes ("Swiss Contributed Surplus"), subject to certain conditions, is a freely distributable reserve.
Distributions to shareholders from Swiss Contributed Surplus are free from withholding tax. During the second quarter of fiscal 2012, our shareholders approved a resolution to reclassify Swiss Contributed Surplus in the amount of CHF 9,745 million from free reserves (contributed surplus) to legal reserves (reserves from capital contributions) on our Swiss statutory balance sheet, a provisional reclassification made while we were in discussions with the Swiss tax authorities. Also during the second quarter of fiscal 2012, we received a favorable outcome from the Swiss tax authorities related to our classification of Swiss Contributed Surplus that allows us to present Swiss Contributed Surplus as a free reserve on our statutory Swiss balance sheet. On July 25, 2012, our shareholders approved a resolution to reclassify Swiss Contributed Surplus in the amount of CHF 9,745 million from legal reserves (reserves from capital contributions) as of March 30, 2012 to free reserves (reserves from capital contributions) on our Swiss statutory balance sheet, with effect as of March 30, 2012. This reclassification will be reflected on our Swiss statutory financial statements for the year ending September 28, 2012. As of September 30, 2011, Swiss Contributed Surplus was $8,940 million (equivalent to CHF 9,745 million).
Dividends and Distributions to Shareholders
Under Swiss law, subject to certain conditions, distributions to shareholders made in the form of a reduction of registered share capital or from reserves from capital contributions (equivalent to Swiss Contributed Surplus) are exempt from Swiss withholding tax. See "Contributed Surplus" for additional information regarding our ability to make distributions free from withholding tax from contributed surplus. Distributions or dividends on our shares must be approved by our shareholders.
In March 2011, our shareholders approved a dividend payment to shareholders of CHF 0.68 (equivalent to $0.72) per share out of contributed surplus, payable in four equal quarterly installments beginning in the third quarter of fiscal 2011 through the second quarter of fiscal 2012 to shareholders of record on specified dates in each of the four quarters. We paid the third and fourth installments of the dividend at a rate of $0.18 per share each during the quarters ended December 30, 2011 and March 30, 2012.
In March 2012, our shareholders approved a cash distribution to shareholders in the form of a capital reduction to the par value of our common shares of CHF 0.80 (equivalent to $0.84) per share, payable in four equal quarterly installments beginning in the third quarter of fiscal 2012 through the second quarter of fiscal 2013 to shareholders of record on specified dates in each of the four quarters. We paid the first installment of the distribution at a rate of $0.21 per share during the quarter ended June 29, 2012. This capital reduction reduced the par value of our common shares from CHF 1.37 (equivalent to $1.28) to CHF 1.17 (equivalent to $1.07).
Upon approval by the shareholders of a dividend payment or cash distribution in the form of a capital reduction, we record a liability with a corresponding charge to contributed surplus or common shares. At June 29, 2012 and September 30, 2011, the unpaid portion of dividends and distributions
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recorded in accrued and other current liabilities on the Condensed Consolidated Balance Sheets totaled $269 million and $153 million, respectively.
Share Repurchase Program
During the first nine months of fiscal 2012, we did not purchase any of our common shares under our share repurchase authorization. During the third quarter and first nine months of fiscal 2011, we purchased approximately 7 million and 16 million, respectively, of our common shares for $267 million and $564 million, respectively. At June 29, 2012, we had $1,501 million of availability remaining under our share repurchase authorization.
19. Comprehensive Income
Comprehensive income consisted of the following:
Currency translation(1)
Gain (loss) on cash flow hedges, net of income taxes
Effects of unrecognized pension and postretirement benefit costs, net of income taxes(2)
Less: comprehensive income attributable to noncontrolling interests
Comprehensive income attributable to TE Connectivity Ltd.
20. Share Plans
Share-based compensation expense was $18 million and $19 million during the quarters ended June 29, 2012 and June 24, 2011, respectively, and $54 million and $60 million during the nine months ended June 29, 2012 and June 24, 2011, respectively. These expenses were primarily presented in selling, general, and administrative expenses on the Condensed Consolidated Statements of Operations.
Pursuant to the acquisition of ADC, we exchanged unexercised ADC share options and stock appreciation rights for our share options and stock appreciation right awards. As a result of that exchange, we recognized $2 million of incremental share-based compensation expense during the first nine months of fiscal 2011. Those costs, which are included in the total share-based compensation expense above, are presented in acquisition and integration costs on the Condensed Consolidated Statements of Operations.
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20. Share Plans (Continued)
On March 7, 2012, our shareholders approved an increase of 20 million shares in the number of shares available for awards under the TE Connectivity Ltd. 2007 Stock and Incentive Plan, as amended and restated (the "2007 Plan"). As of June 29, 2012, we had 27 million shares available for issuance under the 2007 Plan and 4 million shares available for issuance under ADC equity incentive plans.
Restricted Share Awards
A summary of restricted share award activity during the nine months ended June 29, 2012 is presented below:
Non-vested at September 30, 2011
Granted
Vested
Forfeited
Non-vested at June 29, 2012
As of June 29, 2012, there was $94 million of unrecognized compensation cost related to non-vested restricted share awards. The cost is expected to be recognized over a weighted-average period of 1.8 years.
Share Options
A summary of share option award activity during the nine months ended June 29, 2012 is presented below:
Outstanding at September 30, 2011
Exercised
Expired
Outstanding at June 29, 2012
Vested and non-vested expected to vest at June 29, 2012
Exercisable at June 29, 2012
As of June 29, 2012, there was $46 million of unrecognized compensation cost related to non-vested share options granted under our share option plans. The cost is expected to be recognized over a weighted-average period of 1.8 years.
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Share-Based Compensation Assumptions
The weighted-average grant-date fair value of options granted during the nine months ended June 29, 2012 and the weighted-average assumptions we used in the Black-Scholes-Merton option pricing model for the nine months then ended were as follows:
Weighted-average grant-date fair value
Assumptions:
Expected share price volatility
Risk free interest rate
Expected annual dividend per share
Expected life of options (in years)
21. Segment Data
Net sales by segment were as follows:
Total(1)
Operating income by segment was as follows:
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21. Segment Data (Continued)
Segment assets and a reconciliation of segment assets to total assets were as follows:
Total segment assets(1)
Other non-current assets
22. Tyco Electronics Group S.A.
TEGSA, a Luxembourg company and our 100%-owned subsidiary, is a holding company that owns, directly or indirectly, all of our operating subsidiaries. TEGSA is the obligor under our senior notes, commercial paper, and Credit Facility, which are fully and unconditionally guaranteed by its parent, TE Connectivity Ltd. The following tables present condensed consolidating financial information for TE Connectivity Ltd., TEGSA, and all other subsidiaries that are not providing a guarantee of debt but which represent assets of TEGSA, using the equity method of accounting.
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22. Tyco Electronics Group S.A. (Continued)
CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS (UNAUDITED) For the Quarter Ended June 29, 2012
Selling, general, and administrative expenses, net(1)
Operating income (loss)
Other income, net
Equity in net income of subsidiaries
Equity in net loss of subsidiaries of discontinued operations
Intercompany interest and fees
Loss from discontinued operations, net of income taxes
Net income attributable to TE Connectivity Ltd., Tyco Electronics Group S.A., or Other Subsidiaries
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CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS (UNAUDITED) For the Quarter Ended June 24, 2011
Other expense, net
Equity in net income of subsidiaries of discontinued operations
Income from discontinued operations, net of income taxes
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CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS (UNAUDITED) For the Nine Months Ended June 29, 2012
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CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS (UNAUDITED) For the Nine Months Ended June 24, 2011
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CONDENSED CONSOLIDATING BALANCE SHEET (UNAUDITED) As of June 29, 2012
Intercompany receivables
Investment in subsidiaries
Intercompany loans receivable
Intercompany payables
Intercompany loans payable
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CONDENSED CONSOLIDATING BALANCE SHEET (UNAUDITED) As of September 30, 2011
Investment in subsidiaries of discontinued operations
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CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS (UNAUDITED) For the Nine Months Ended June 29, 2012
Net cash provided by (used in) continuing operating activities
Net cash provided by (used in) operating activities
Change in intercompany loans
Net cash provided by (used in) continuing investing activities
Net cash provided by (used in) investing activities
Changes in parent company equity(1)
Increase in commercial paper
Loan borrowing with parent
Net increase in cash and cash equivalents
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CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS (UNAUDITED) For the Nine Months Ended June 24, 2011
Acquisition of businesses, net of cash acquired
Decrease in commercial paper
Intercompany distributions
Net cash used in continuing financing activities
Net cash used in financing activities
Net decrease in cash and cash equivalents
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our Condensed Consolidated Financial Statements and the accompanying notes included elsewhere in this Quarterly Report. The following discussion may contain forward-looking statements that reflect our plans, estimates, and beliefs. Our actual results could differ materially from those discussed in these forward-looking statements as a result of many factors, including but not limited to those under the heading "Forward-Looking Information" and "Part II. Item 1A. Risk Factors."
Our Condensed Consolidated Financial Statements have been prepared in United States Dollars, in accordance with accounting principles generally accepted in the United States of America ("GAAP").
Organic net sales growth and free cash flow are non-GAAP financial measures which are discussed in Management's Discussion and Analysis of Financial Condition and Results of Operations. We believe these non-GAAP financial measures, together with GAAP financial measures, provide useful information to investors because they reflect the financial measures that management uses in evaluating the underlying results of our operations. See "Non-GAAP Financial Measures" for more information about these non-GAAP financial measures, including our reasons for including the measures and material limitations with respect to the usefulness of the measures.
Overview
TE Connectivity Ltd. ("TE Connectivity" or the "Company", which may be referred to as "we," "us," or "our") is a global company that designs and manufactures approximately 500,000 products that connect and protect the flow of power and data inside millions of products used by consumers and industries. We partner with customers in a broad array of industries from consumer electronics, energy, and healthcare to automotive, aerospace, and communication networks. We operate through three reportable segments: Transportation Solutions, Communications and Industrial Solutions, and Network Solutions.
Our business and operating results have been and will continue to be affected by worldwide economic conditions. Our sales are dependent on certain industry end markets that are impacted by consumer as well as industrial and infrastructure spending, and our operating results can be affected by changes in demand in those markets. Overall, our net sales decreased 2.2% and 1.1% in the third quarter and first nine months of fiscal 2012, respectively, as compared to the same periods of fiscal 2011. On an organic basis, net sales decreased 3.1% and 2.5% in the third quarter and first nine months of fiscal 2012, respectively, as compared to the same periods of fiscal 2011. On an organic basis, we experienced declines in our sales into industrial and infrastructure based markets, primarily as a result of weakness in the industrial and data communications end markets in our Communications and Industrial Solutions segment and telecom networks and subsea communications end markets in our Network Solutions segment. On an organic basis, we experienced growth in our sales into consumer based markets, as growth in the automotive end market in our Transportation Solutions segment was partially offset by declines within the consumer devices and appliance end markets in our Communications and Industrial Solutions segment. The acquisition of Deutsch Group SAS ("Deutsch") in April 2012 benefited the automotive and aerospace, defense, and marine end markets in the Transportation Solutions segment. Deutsch contributed net sales of $174 million in the third quarter of fiscal 2012.
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Outlook
Net sales in the fourth quarter of fiscal 2012 are expected to be between $3.325 billion and $3.425 billion. This reflects declines in the Communications and Industrial Solutions and Network Solutions segments as compared to the fourth quarter of fiscal 2011. The Transportation Solutions segment will benefit from Deutsch sales which are expected to be approximately $180 million in the fourth quarter of fiscal 2012. We expect global automotive production to increase approximately 1% relative to the fourth quarter of fiscal 2011. During the fourth quarter of fiscal 2012, we expect the Communications and Industrial Solutions segment to be adversely impacted by continued weakness in the industrial, data communications, and appliance end markets. We also expect the Network Solutions segment to be negatively impacted by lower carrier spending in the telecom networks end market. In the fourth quarter of fiscal 2012, we expect diluted earnings per share to be in the range of $0.64 to $0.68 per share.
For fiscal 2012, we expect net sales to be between $13.25 billion and $13.35 billion, reflecting decreases in all end markets in the Communications and Industrial Solutions and Network Solutions segments from fiscal 2011 levels, partially offset by an increase in the Transportation Solutions segment. Deutsch sales are expected to be approximately $360 million in fiscal 2012. We expect our sales into the automotive end market to benefit from an anticipated increase in global automotive production of 5% over fiscal 2011 levels. We expect diluted earnings per share to be in the range of $2.41 to $2.45 per share for fiscal 2012.
The above outlook assumes current foreign exchange and commodity rates.
We are monitoring the current environment and its potential effects on our customers and on the end markets we serve. Additionally, we continue to closely manage our costs in order to respond to changing conditions. We are also managing our capital resources and monitoring capital availability to ensure that we have sufficient resources to fund our future capital needs. (See further discussion in "Liquidity and Capital Resources.")
On April 3, 2012, we acquired 100% of the outstanding shares of Deutsch. The total value paid for the transaction amounted to €1.55 billion (approximately $2.05 billion using an exchange rate of $1.33 per €1.00), net of cash acquired. The total value paid included $659 million related to the repayment of Deutsch's financial debt plus accrued interest. Deutsch is a global leader in high-performance connectors for harsh environments, and significantly expands our product portfolio and enables us to better serve customers in the industrial and commercial transportation, aerospace, defense, and marine, and rail markets. This acquisition is reported primarily as part of our Transportation Solutions segment from the date of acquisition.
See additional information regarding the acquisition of Deutsch in Note 4 to the Condensed Consolidated Financial Statements.
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Discontinued Operations
On June 1, 2012, we sold our Touch Solutions business for net cash proceeds of $380 million, subject to working capital adjustments, of which we received $370 million during the quarter ended June 29, 2012. Also, on April 27, 2012, we sold our TE Professional Services business for net cash proceeds of $29 million, of which we received $24 million during the quarter ended June 29, 2012. These businesses met the held for sale and discontinued operations criteria and have been included in discontinued operations in all periods presented. Prior to reclassification to discontinued operations, the Touch Solutions and TE Professional Services businesses were included in the Communications and Industrial Solutions and Network Solutions segments, respectively.
See Note 5 to the Condensed Consolidated Financial Statements for additional information regarding discontinued operations.
Acquisition Related Restructuring
During fiscal 2012, we initiated a restructuring plan associated with the integration of Deutsch, which is expected to generate cost efficiencies in our consolidated operations. We expect to incur restructuring charges of approximately $12 million during fiscal 2012, primarily related to employee severance and benefits. As discussed above, in the first nine months of fiscal 2012, we recorded charges of $11 million related to this plan. Cash spending related to this plan was $4 million in the first nine months of fiscal 2012. We expect total cash spending, which will be funded with cash from operations, to be approximately $10 million in fiscal 2012. Annualized cost savings related to these actions are expected to be approximately $9 million and will be realized in fiscal 2013. Cost savings will be reflected primarily in cost of sales and selling, general, and administrative expenses.
Manufacturing Simplification
We plan to continue to simplify our global manufacturing footprint by migrating facilities from higher-cost to lower-cost countries, consolidating within countries, and transferring product lines to lower-cost countries. These initiatives are designed to help us maintain our competitiveness in the industry, improve our operating leverage, and position us for profitability growth in the years ahead.
In connection with our manufacturing simplification plan, we incurred restructuring charges of approximately $80 million during the first nine months of fiscal 2012 and expect to incur restructuring charges of approximately $110 million during fiscal 2012. In the first nine months of fiscal 2012, cash spending related to restructuring was $102 million. We expect total spending, which will be funded with cash from operations, to be approximately $150 million in fiscal 2012. Annualized cost savings related to these actions are expected to be approximately $85 million. Cost savings will be reflected primarily in cost of sales and selling, general, and administrative expenses.
Results of Operations
Consolidated Operations
Key business factors that influenced our results of operations during the periods discussed in this report include:
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levels, they remain high relative to historic levels. The following table sets forth the average prices incurred related to copper, gold, and silver during the periods presented:
Copper
Gold
Silver
U.S. Dollar
Euro
Japanese Yen
Chinese Renminbi
Korean Won
Brazilian Real
British Pound Sterling
All others
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The following table sets forth certain items from our Condensed Consolidated Statements of Operations and the percentage of net sales that such items represent for the periods shown.
Net Sales. Net sales decreased $80 million, or 2.2%, to $3,499 million in the third quarter of fiscal 2012 from $3,579 million in the third quarter of fiscal 2011. The decrease was primarily a result of lower net sales in the Communications and Industrial Solutions and Network Solutions segments, partially offset by an increase in net sales in the Transportation Solutions segment. Deutsch, which was acquired on April 3, 2012, contributed net sales of $174 million in the third quarter of fiscal 2012. Foreign currency exchange rates negatively affected net sales by $143 million in the third quarter of fiscal 2012 as compared to the same period of fiscal 2011. On an organic basis, net sales decreased $111 million, or 3.1%, in the third quarter of fiscal 2012 as compared to the third quarter of fiscal 2011.
In the first nine months of fiscal 2012, net sales decreased $107 million, or 1.1%, to $9,918 million from $10,025 million in the first nine months of fiscal 2011. The decrease was due primarily to decreased net sales in the Communications and Industrial Solutions segment, and to a lesser degree the Network Solutions segment, partially offset by increased net sales in the Transportation Solutions segment. Deutsch contributed net sales of $174 million in the first nine months of fiscal 2012. Foreign currency exchange rates negatively affected net sales by $184 million in the first nine months of fiscal 2012 as compared to the same period of fiscal 2011. On an organic basis, net sales decreased $251 million, or 2.5%, in the first nine months of fiscal 2012 as compared to the first nine months of fiscal 2011. See further discussion of organic net sales below under Results of Operations by Segment.
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The following table sets forth the percentage of our total net sales by geographic region:
Europe/Middle East/Africa (EMEA)
Asia-Pacific
Americas
The following table provides an analysis of the change in our net sales by geographic region:
EMEA
The following table sets forth the percentage of our total net sales by segment:
The following table provides an analysis of the change in our net sales by segment:
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Gross Margin. Gross margin decreased $70 million to $1,018 million in the third quarter of fiscal 2012 from $1,088 million in the third quarter of fiscal 2011. Gross margin as a percentage of net sales decreased to 29.1% in the third quarter of fiscal 2012 from 30.4% in the same period of fiscal 2011. The decline in gross margin resulted primarily from charges of $68 million associated with the amortization of acquisition accounting-related fair value adjustments primarily related to acquired inventories and customer order backlog associated with Deutsch in the third quarter of fiscal 2012 as compared to charges of $2 million associated with the amortization of acquisition accounting-related adjustments associated with ADC Telecommunications, Inc. ("ADC") in the third quarter of fiscal 2011. Excluding these items, gross margin was flat as improved manufacturing productivity and the gross margin on incremental Deutsch sales largely offset the impact of decreased volume.
Gross margin decreased $105 million to $2,982 million in the first nine months of fiscal 2012 from $3,087 million in the first nine months of fiscal 2011. Gross margin as a percentage of net sales decreased to 30.1% in the first nine months of fiscal 2012 from 30.8% in the same period of fiscal 2011. In the first nine months of fiscal 2012, gross margin included charges of $68 million associated with the amortization of acquisition accounting-related fair value adjustments primarily related to acquired inventories and customer order backlog associated with Deutsch, whereas, in the first nine months of fiscal 2011, gross margin included charges of $38 million associated with the amortization of acquisition accounting-related fair value adjustments primarily related to acquired inventories and customer order backlog associated with ADC. In addition, gross margin was negatively impacted by decreased volume and increased material costs, partially offset by improved manufacturing productivity and the gross margin on incremental ADC and Deutsch sales.
Selling, General, and Administrative Expenses. Selling, general, and administrative expenses decreased $18 million to $423 million in the third quarter of fiscal 2012 from $441 million in the third quarter of fiscal 2011. Selling, general, and administrative expenses as a percentage of net sales were 12.1% and 12.3% in the third quarters of fiscal 2012 and 2011, respectively. Selling, general, and administrative expenses decreased $28 million to $1,233 million in the first nine months of fiscal 2012 from $1,261 million in the first nine months of fiscal 2011. Selling, general, and administrative expenses as a percentage of net sales were 12.4% and 12.6% in the first nine months of fiscal 2012 and 2011, respectively.
Acquisition and Integration Costs. In connection with the acquisition of Deutsch, we incurred acquisition and integration costs of $15 million and $23 million during the third quarter and first nine months of fiscal 2012, respectively. We incurred acquisition and integration costs of $1 million and $19 million during the third quarter and first nine months of fiscal 2011, respectively, in connection with the acquisition of ADC.
Restructuring and Other Charges, Net. Net restructuring and other charges were $36 million in the third quarter of fiscal 2012 as compared to $8 million in the same period of fiscal 2011. Net restructuring and other charges were $86 million in the first nine months of fiscal 2012 and $58 million in the first nine months of fiscal 2011. We initiated restructuring programs during fiscal 2012 associated with the acquisition of Deutsch and related headcount reductions primarily in the Transportations Solutions segment as well as headcount reductions in the Communications and Industrial Solutions segment. Fiscal 2011 actions were primarily associated with the acquisition of ADC and related headcount reductions in the Network Solutions segment. See Note 3 to the Condensed Consolidated Financial Statements for additional information regarding net restructuring and other charges.
Operating Income. In the third quarter of fiscal 2012, operating income was $371 million as compared to $460 million in the third quarter of fiscal 2011. As discussed above, results for the third quarter of fiscal 2012 included $94 million of charges related to the acquisition of Deutsch, including $68 million of charges associated with the amortization of acquisition accounting-related fair value adjustments primarily related to acquired inventories and customer order backlog, $15 million of
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acquisition and integration costs, and $11 million of net restructuring and other charges. The third quarter of fiscal 2012 also included $25 million of additional restructuring and other charges. Results for the third quarter of fiscal 2011 included $10 million of charges related to the acquisition of ADC, including $7 million of net restructuring and other charges, $2 million of charges associated with the amortization of acquisition accounting-related adjustments, and $1 million of acquisition and integration costs. Results also included $1 million of additional restructuring and other charges in the third quarter of fiscal 2011. Excluding these items, the increase in operating income resulted from improved manufacturing productivity and the impact of the Deutsch acquisition, partially offset by the unfavorable impact of decreased volume.
Operating income was $1,117 million and $1,242 million in the first nine months of fiscal 2012 and 2011, respectively. Results for the first nine months of fiscal 2012 included $102 million of charges related to the acquisition of Deutsch, including $68 million of charges associated with the amortization of acquisition accounting-related fair value adjustments primarily related to acquired inventories and customer order backlog, $23 million of acquisition and integration costs, and $11 million of net restructuring and other charges. The first nine months of fiscal 2012 also included $75 million of additional restructuring and other charges. Results for the first nine months of fiscal 2011 included $115 million of charges related to the acquisition of ADC, including $58 million of net restructuring and other charges, $38 million of charges associated with the amortization of acquisition accounting-related fair value adjustments primarily related to acquired inventories and customer order backlog, and $19 million of acquisition and integration costs. Excluding these items, the decrease in operating income resulted from the unfavorable impacts of decreased volume, and to a lesser degree, increased material costs, partially offset by improved manufacturing productivity and the impact of the Deutsch acquisition.
Non-Operating Items
Other Income, Net
We recorded net other income of $19 million and net other expense of $5 million in the quarters ended June 29, 2012 and June 24, 2011, respectively, and net other income of $31 million and $13 million in the nine months ended June 29, 2012 and June 24, 2011, respectively, primarily consisting of income pursuant to the Tax Sharing Agreement with Tyco International Ltd. ("Tyco International") and Covidien plc ("Covidien"). During the third quarter of fiscal 2011, we recorded other expense of $14 million in connection with the completion of fieldwork and the settlement of certain U.S. tax matters. See additional information in Note 11 to the Condensed Consolidated Financial Statements.
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Income (Loss) from Discontinued Operations, Net of Income Taxes
Loss from discontinued operations was $61 million and income from discontinued operations was $6 million in the third quarters of fiscal 2012 and 2011, respectively. In the first nine months of fiscal 2012 and 2011, loss from discontinued operations was $49 million and income from discontinued operations was $16 million, respectively.
On June 1, 2012, we sold our Touch Solutions business for net cash proceeds of $380 million, subject to working capital adjustments, of which we received $370 million during the quarter ended June 29, 2012. We recognized an insignificant pre-tax loss on the transaction. The agreement includes contingent earn-out provisions through 2015 based on business performance. In connection with the divestiture, we incurred an income tax charge of $65 million, which is included in income (loss) from discontinued operations, net of income taxes on the Condensed Consolidated Statement of Operations for the quarter ended June 29, 2012, primarily as a result of being unable to realize a tax benefit from the write-off of goodwill at the time of the sale. We expect to make tax payments of approximately $10 million associated with this divestiture.
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Results of Operations by Segment
Operating margin
The following table sets forth Transportation Solutions' percentage of total net sales by primary industry end market(1):
Automotive
Aerospace, Defense, and Marine
The following table provides an analysis of the change in Transportation Solutions' net sales by primary industry end market:
Quarter Ended June 29, 2012 Compared to Quarter Ended June 24, 2011
Transportation Solutions' net sales increased $181 million, or 12.7%, to $1,607 million in the third quarter of fiscal 2012 from $1,426 million in the same period of fiscal 2011. Organic net sales increased by $86 million, or 6.1%, in the third quarter of fiscal 2012 as compared to the third quarter of fiscal 2011 due primarily to an increase of $85 million in the automotive end market. Deutsch contributed net sales of $174 million in the third quarter of fiscal 2012. The weakening of certain foreign currencies negatively affected net sales by $79 million in the third quarter of fiscal 2012 as compared to the same period of fiscal 2011.
In the automotive end market, our organic net sales increased 6.9% in the third quarter of fiscal 2012 as compared to the third quarter of fiscal 2011. The increase resulted from growth of 21.6% in the Asia-Pacific region and 10.7% in the Americas region, partially offset by a decline of 3.6% in the
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EMEA region. Growth in the Asia-Pacific region resulted from higher automotive production and continued recovery following the earthquake in Japan. We estimate that the earthquake in Japan negatively impacted our sales in the automotive end market by $36 million in the third quarter of fiscal 2011. In the Americas region, growth resulted from increased production in North America, partially offset by weakness in South America. In the EMEA region, production levels decreased as a result of financial uncertainty in Europe. In the aerospace, defense, and marine end markets, our organic net sales were flat in the third quarter of fiscal 2012 as compared to the same period in fiscal 2011 as growth in commercial aviation due to increased production and growth in the marine market driven by share gains and increased oil and gas exploration was offset by declines in the defense market.
In the third quarter of fiscal 2012, Transportation Solutions' operating income decreased $28 million to $183 million from $211 million in the third quarter of fiscal 2011. Segment results for the third quarter of fiscal 2012 included $94 million of charges related to the acquisition of Deutsch, including $68 million of charges associated with the amortization of acquisition accounting-related fair value adjustments primarily related to acquired inventories and customer order backlog, $15 million of acquisition and integration costs, and $11 million of restructuring and other charges. Segment results also included $3 million of additional restructuring and other charges in the third quarter of fiscal 2012 and $13 million of net restructuring and other credits in the third quarter of fiscal 2011. Excluding these items, the increase in operating income resulted primarily from the Deutsch acquisition, favorable impacts of increased volume and pricing actions, and improved manufacturing productivity.
Nine Months Ended June 29, 2012 Compared to Nine Months Ended June 24, 2011
In the first nine months of fiscal 2012, Transportation Solutions' net sales increased $375 million, or 9.2%, to $4,469 million from $4,094 million in the first nine months of fiscal 2011. Organic net sales increased by $301 million, or 7.3%, in the first nine months of fiscal 2012 as compared to the same period of fiscal 2011 due primarily to an increase of $264 million in the automotive end market. Deutsch contributed net sales of $174 million in the first nine months of fiscal 2012. The weakening of certain foreign currencies negatively affected net sales by $100 million in the first nine months of fiscal 2012 as compared to the same period of fiscal 2011.
In the automotive end market, our organic net sales increased 7.3% in the first nine months of fiscal 2012 as compared to the same period of fiscal 2011. The increase was due primarily to growth in the Asia-Pacific region of 16.0% and in the Americas region of 11.4%, partially offset by a decline of 0.2% in the EMEA region. Growth in the Asia-Pacific region resulted from higher automotive production and continued recovery following the earthquake in Japan. We estimate that the earthquake in Japan negatively impacted our sales in the automotive end market by $38 million in the first nine months of fiscal 2011. In the Americas region, growth resulted from increased production in North America, partially offset by declines in South America. In the EMEA region, production levels decreased as a result of financial uncertainty in Europe. In the aerospace, defense, and marine end markets, our organic net sales increased 7.0% in the first nine months of fiscal 2012 as compared to the first nine months of fiscal 2011. The increase was attributable to growth in commercial aviation resulting from increased production, and growth in the marine market resulting from share gains and increased oil and gas exploration driven by increased crude oil prices.
Transportation Solutions' operating income increased $22 million to $633 million in the first nine months of fiscal 2012 from $611 million in the same period of fiscal 2011. Segment results for the first nine months of fiscal 2012 included $102 million of charges related to the acquisition of Deutsch, including $68 million of charges associated with the amortization of acquisition accounting-related fair value adjustments primarily related to acquired inventories and customer order backlog, $23 million of acquisition and integration costs, and $11 million of restructuring and other charges. Segment results also included $1 million of additional restructuring and other charges in the first nine months of fiscal 2012 and $18 million of net restructuring and other credits in the first nine months of fiscal 2011.
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Excluding these items, the increase in operating income resulted primarily from the favorable impacts of increased volume and pricing actions, the Deutsch acquisition, and improved manufacturing productivity.
The following table sets forth Communications and Industrial Solutions' percentage of total net sales by primary industry end market(1):
Industrial
Consumer Devices
Data Communications
Appliance
The following table provides an analysis of the change in Communications and Industrial Solutions' net sales by primary industry end market:
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Communications and Industrial Solutions' net sales decreased $139 million, or 11.7%, to $1,045 million in the third quarter of fiscal 2012 from $1,184 million in the third quarter of fiscal 2011. Organic net sales decreased $111 million, or 9.4%, during the third quarter of fiscal 2012 as compared to the same period of fiscal 2011. We estimate that the earthquake in Japan negatively impacted our sales in the Communications and Industrial Solutions segment by $32 million in the third quarter of fiscal 2011. The weakening of certain foreign currencies negatively affected net sales by $28 million in the third quarter of fiscal 2012 as compared to the same period of fiscal 2011.
In the industrial end market, our organic net sales decreased 13.6% in the third quarter of fiscal 2012 as compared to the third quarter of fiscal 2011 primarily as a result of market weakness, particularly in the Asia-Pacific and EMEA regions. In the consumer devices end market, our organic net sales decreased 3.6% in the third quarter of fiscal 2012 as compared to the same period of fiscal 2011 due to weaker demand in the personal computer market, partially offset by strong demand in the tablet computer market and increased demand in the mobile phone market. In the data communications end market, our organic net sales decreased 14.9% in the third quarter of fiscal 2012 from the same period of fiscal 2011 due to market softness, primarily in the Asia-Pacific region. In the appliance end market, our organic net sales decreased 2.9% in the third quarter of fiscal 2012 as compared to the third quarter of fiscal 2011 primarily as a result of weakness in the Asia-Pacific region, resulting from lower demand, partially offset by growth in demand in the Americas region.
In the third quarter of fiscal 2012, Communications and Industrial Solutions' operating income decreased $24 million to $96 million from $120 million in the same period of fiscal 2011. Segment results included restructuring and other charges of $16 million in the third quarter of fiscal 2012 and $11 million in the third quarter of fiscal 2011. Excluding these items, the decrease in operating income resulted from the unfavorable impacts of decreased volume and increased materials cost, partially offset by improved manufacturing productivity.
In the first nine months of fiscal 2012, Communications and Industrial Solutions' net sales decreased $439 million, or 12.8%, to $2,994 million from $3,433 million in the same period of fiscal 2011. Organic net sales decreased $418 million, or 12.2%, during the first nine months of fiscal 2012 as compared to the first nine months of fiscal 2011. We estimate that the earthquake in Japan negatively impacted our sales in the Communications and Industrial Solutions segment by $46 million in the first nine months of fiscal 2011. The weakening of certain foreign currencies negatively affected net sales by $21 million in the first nine months of fiscal 2012 as compared to the same period of fiscal 2011.
In the industrial end market, our organic net sales decreased 14.2% in the first nine months of fiscal 2012 as compared to the same period of fiscal 2011 due primarily to market weakness, particularly in the EMEA and Asia-Pacific regions. In the consumer devices end market, our organic net sales decreased 7.8% in the first nine months of fiscal 2012 as compared to the first nine months of fiscal 2011 as a result of weaker demand in the personal computer and consumer electronics markets, partially offset by strong demand in the tablet computer market and increased demand in the mobile phone market. In the data communications end market, our organic net sales decreased 17.7% in the first nine months of fiscal 2012 from the same period of fiscal 2011 as a result of market softness, primarily in the Asia-Pacific region, and inventory reductions in the supply chain. In the appliance end market, our organic net sales decreased 7.6% in the first nine months of fiscal 2012 as compared to the same period of fiscal 2011 due primarily to weakness in the Asia-Pacific and EMEA regions, resulting from lower demand and inventory reductions in the supply chain, partially offset by growth in demand in the Americas region.
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Communications and Industrial Solutions' operating income decreased $194 million to $232 million in the first nine months of fiscal 2012 from $426 million in the first nine months of fiscal 2011. Segment results included restructuring and other charges of $51 million and $14 million in the first nine months of fiscal 2012 and 2011, respectively. Excluding these items, the decrease in operating income resulted from the unfavorable impacts of decreased volume and increased materials costs, partially offset by improved manufacturing productivity.
The following table sets forth Network Solutions' percentage of total net sales by primary industry end market(1):
Telecom Networks
Energy
Enterprise Networks
Subsea Communications
The following table provides an analysis of the change in Network Solutions' net sales by primary industry end market:
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In the third quarter of fiscal 2012, Network Solutions' net sales decreased $122 million, or 12.6%, to $847 million from $969 million in the third quarter of fiscal 2011. Organic net sales decreased $86 million, or 8.9%, in the third quarter of fiscal 2012 from the same period of fiscal 2011. The weakening of certain foreign currencies negatively affected net sales by $36 million in the third quarter of fiscal 2012 as compared to the same period of fiscal 2011.
In the telecom networks end market, our organic net sales decreased 14.5% in the third quarter of fiscal 2012 as compared to the same period of fiscal 2011 largely due to decreased capital investments by major carriers in the telecommunications industry, particularly in the Americas and EMEA regions. In the energy end market, our organic net sales increased 3.4% in the third quarter of fiscal 2012 as compared to the third quarter of fiscal 2011 as a result of growth across all regions. In the enterprise networks end market, our organic sales decreased 2.4% in the third quarter of fiscal 2012 from fiscal 2011 levels due to softness in office networks, partially offset by continued data center investments. The subsea communications end market's organic net sales decreased 20.5% in the third quarter of fiscal 2012 as compared to the same period of fiscal 2011 due to lower levels of project activity.
Network Solutions' operating income decreased $37 million to $92 million in the third quarter of fiscal 2012 from $129 million in the same period of fiscal 2011. Segment results for the third quarter of fiscal 2012 included $6 million of restructuring and other charges. Segment results for the third quarter of fiscal 2011 included $10 million of charges related to the acquisition of ADC, including $7 million of restructuring and other charges, $2 million of charges associated with the amortization of acquisition accounting-related adjustments, and $1 million of acquisition and integration costs. The third quarter of fiscal 2011 also included additional restructuring and other charges of $3 million. Excluding these items, the decrease in operating income was attributable primarily to the unfavorable impact of decreased volume.
Network Solutions' net sales decreased $43 million, or 1.7%, to $2,455 million in the first nine months of fiscal 2012 from $2,498 million in the same period of fiscal 2011. Organic net sales decreased $134 million, or 5.4%, in the first nine months of fiscal 2012 from the first nine months of fiscal 2011. The weakening of certain foreign currencies negatively affected net sales by $63 million in the first nine months of fiscal 2012 as compared to the same period of fiscal 2011. The acquisition of ADC on December 8, 2010 resulted in incremental net sales of $154 million in the first quarter of fiscal 2012 over the same period of fiscal 2011, as ADC contributed net sales of $198 million in the first quarter of fiscal 2012 as compared to $44 million in the first quarter of fiscal 2011.
In the telecom networks end market, our organic net sales decreased 9.0% in the first nine months of fiscal 2012 as compared to the first nine months of fiscal 2011 due primarily to decreased capital investments by major carriers in the telecommunications industry, particularly in the Americas and EMEA regions. In the energy end market, our organic net sales increased 2.7% in the first nine months of fiscal 2012 as compared to the same period of fiscal 2011 as a result of growth in the Americas and Asia-Pacific regions. In the enterprise networks end market, our organic net sales were flat in the first nine months of fiscal 2012 from fiscal 2011 levels as increases resulting from continued data center investments were offset by declines resulting from softness in office networks. The subsea communications end market's organic net sales decreased 15.9% in the first nine months of fiscal 2012 as compared to the first nine months of fiscal 2011 as a result of lower levels of project activity.
In the first nine months of fiscal 2012, Network Solutions' operating income increased $47 million to $252 million from $205 million in the first nine months of fiscal 2011. Segment results for the first nine months of fiscal 2012 included $23 million of restructuring and other charges. Segment results for the first nine months of fiscal 2011 included $115 million of charges related to the acquisition of ADC,
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including $58 million of restructuring and other charges, $38 million of charges associated with the amortization of acquisition accounting-related fair value adjustments primarily related to acquired inventories and customer order backlog, and $19 million of acquisition and integration costs. The first nine months of fiscal 2011 also included additional restructuring and other charges of $4 million. Excluding these items, the decrease in operating income was attributable to the unfavorable impact of decreased volume, partially offset by improved manufacturing productivity.
Liquidity and Capital Resources
Our ability to fund our future capital needs will be affected by our ability to continue to generate cash from operations and may be affected by our ability to access the capital markets, money markets, or other sources of funding, as well as the capacity and terms of our financing arrangements. We believe that cash generated from operations and, to the extent necessary, these other sources of potential funding will be sufficient to meet our anticipated capital needs for the foreseeable future, including the payment of our 6.00% senior notes due in October 2012. We may use excess cash to reduce our outstanding debt, including through the possible repurchase of our debt in accordance with applicable law, to purchase a portion of our common shares pursuant to our authorized share repurchase program, to pay distributions or dividends on our common shares, or to acquire strategic businesses or product lines. The cost or availability of future funding may be impacted by financial market conditions. We will continue to monitor financial markets, to respond as necessary to changing conditions.
Cash Flows from Operating Activities
In the first nine months of fiscal 2012, net cash provided by continuing operating activities increased $60 million to $1,174 million from $1,114 million in the first nine months of fiscal 2011. The increase resulted from improved working capital offset by higher income taxes paid and lower income levels.
The amount of income taxes paid, net of refunds, was $240 million and $127 million during the first nine months of fiscal 2012 and 2011, respectively. Payments during the first nine months of fiscal 2012 included $70 million for tax deficiencies related to U.S. tax matters for the years 1997 through 2000. Also during the first nine months of fiscal 2012, we received net reimbursements of $44 million from Tyco International and Covidien pursuant to their indemnifications for pre-separation U.S. tax matters.
We expect to make net cash payments related to pre-separation tax matters of approximately $26 million over the next twelve months. These amounts include payments in which we are the primary obligor to the taxing authorities and for which we expect a portion to be reimbursed by Tyco International and Covidien under the Tax Sharing Agreement as well as indemnification payments to Tyco International and Covidien under the Tax Sharing Agreement for tax matters where they are the primary obligor to the taxing authorities. See Note 11 to the Condensed Consolidated Financial Statements for additional information related to pre-separation tax matters.
In addition to net cash provided by operating activities, we use free cash flow, a non-GAAP financial measure, as a useful measure of our performance and ability to generate cash. Free cash flow was $865 million in the first nine months of fiscal 2012 as compared to $802 million in the first nine months of fiscal 2011. The increase was primarily driven by improved working capital, as adjusted for net payments for pre-separation tax matters of $26 million and certain Deutsch acquisition-related payments totaling $37 million, partially offset by higher income taxes paid, lower income levels, and increased net capital expenditures. The following table sets forth a reconciliation of net cash provided by continuing operating activities, the most comparable GAAP financial measure, to free cash flow.
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Payments related to pre-separation U.S. tax matters, net
Payments related to accrued interest on debt assumed in the acquisition of Deutsch
Payments to settle acquisition-related foreign currency derivative contracts
Free cash flow
Cash Flows from Investing Activities
We continue to fund capital expenditures to support new programs and to invest in machinery and our manufacturing facilities to further enhance productivity and manufacturing capabilities. In the first nine months of fiscal 2012, capital spending increased $15 million to $385 million from $370 million in the first nine months of fiscal 2011. We expect fiscal 2012 capital spending levels to be approximately 4% of net sales.
In the first nine months of fiscal 2012, we acquired Deutsch. The total value paid for the transaction amounted to €1.55 billion (approximately $2.05 billion using an exchange rate of $1.33 per €1.00), net of cash acquired of $152 million. The total value paid included $659 million of debt assumed, including accrued interest, and paid off in its entirety shortly after the completion of the acquisition. See additional information in Note 4 to the Condensed Consolidated Financial Statements.
In the first nine months of fiscal 2011, we acquired ADC for a total purchase price of approximately $1,263 million in cash (excluding cash acquired of $546 million) and $22 million of other non-cash consideration. Short-term investments acquired in connection with the acquisition of ADC were sold for proceeds of $155 million in the first nine months of fiscal 2011. Certain other assets acquired in connection with the acquisition of ADC were sold for net proceeds of $111 million, of which approximately $106 million was received in the first nine months of fiscal 2011. We also acquired a business for $14 million in cash in the first nine months of fiscal 2011.
In the first nine months of fiscal 2012, we received net cash proceeds of $370 million related to the sale of our Touch Solutions business and $24 million related to the sale of our TE Professional Services business.
Cash Flows from Financing Activities and Capitalization
Total debt at June 29, 2012 and September 30, 2011 was $3,759 million and $2,667 million, respectively. See Note 9 to the Condensed Consolidated Financial Statements for additional information regarding debt.
During February 2012, Tyco Electronics Group S.A. ("TEGSA"), our wholly-owned subsidiary, issued $250 million aggregate principal amount of 1.60% senior notes due February 3, 2015 and $500 million aggregate principal amount of 3.50% senior notes due February 3, 2022. The notes were offered and sold pursuant to an effective registration statement on Form S-3 filed on January 21, 2011. Interest on the notes is payable semi-annually on February 3 and August 3 of each year, beginning August 3, 2012. The notes are TEGSA's unsecured senior obligations and rank equally in right of payment with all existing and any future senior indebtedness of TEGSA and senior to any subordinated indebtedness
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that TEGSA may incur. Net proceeds from the issuance of the notes due 2015 and 2022, were approximately $250 million and $498 million, respectively. In connection with the issuance of the senior notes in February 2012, the commitments of the lenders under the $700 million 364-day credit agreement, dated as of December 20, 2011, automatically terminated.
The Credit Facility contains a financial ratio covenant providing that if, as of the last day of each fiscal quarter, our ratio of Consolidated Total Debt (as defined in the Credit Facility) to Consolidated EBITDA (as defined in the Credit Facility) for the then most recently concluded period of four consecutive fiscal quarters exceeds 3.5 to 1.0, an Event of Default (as defined in the Credit Facility) is triggered. The Credit Facility and our other debt agreements contain other customary covenants. None of our covenants are presently considered restrictive to our operations. As of June 29, 2012, we were in compliance with all of our debt covenants and believe that we will continue to be in compliance with our existing covenants for the foreseeable future.
Payment of common share dividends and cash distributions to shareholders were $243 million and $220 million in the first nine months of fiscal 2012 and 2011, respectively. In March 2011, our shareholders approved a dividend payment to shareholders of 0.68 Swiss Francs ("CHF") (equivalent to $0.72) per share out of contributed surplus, payable in four equal quarterly installments beginning in the third quarter of fiscal 2011 through the second quarter of fiscal 2012 to shareholders of record on specified dates in each of the four quarters. We paid the third and fourth installments of the dividend at a rate of $0.18 per share each during the quarters ended December 30, 2011 and March 30, 2012.
Distributions to shareholders from Swiss Contributed Surplus are free from withholding tax. During the second quarter of fiscal 2012, our shareholders approved a resolution to reclassify Swiss Contributed Surplus in the amount of CHF 9,745 million from free reserves (contributed surplus) to legal reserves (reserves from capital contributions) on our Swiss statutory balance sheet, a provisional reclassification made while we were in discussions with the Swiss tax authorities. Also during the second quarter of fiscal 2012, we received a favorable outcome from the Swiss tax authorities related to our classification of Swiss Contributed Surplus that allows us to present Swiss Contributed Surplus as a free reserve on our statutory Swiss balance sheet. On July 25, 2012, our shareholders approved a resolution to reclassify Swiss Contributed Surplus in the amount of CHF 9,745 million from legal reserves (reserves from capital contributions) as of March 30, 2012 to free reserves (reserves from capital contributions) on our Swiss statutory balance sheet, with effect as of March 30, 2012. This
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reclassification will be reflected on our Swiss statutory financial statements for the year ending September 28, 2012. See Note 18 to the Condensed Consolidated Financial Statements for additional information.
Backlog
At June 29, 2012, we had a backlog of unfilled orders of $2,915 million compared to a backlog of $2,878 million at September 30, 2011. Backlog by reportable segment was as follows:
Commitments and Contingencies
Income Tax Matters
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During fiscal 2007, the IRS concluded its field examination of certain of Tyco International's U.S. federal income tax returns for the years 1997 through 2000 and issued Revenue Agent Reports which reflect the IRS' determination of proposed tax adjustments for the 1997 through 2000 period. Tyco International has appealed certain proposed adjustments totaling approximately $1 billion. Additionally, the IRS proposed civil fraud penalties against Tyco International arising from alleged actions of former executives in connection with certain intercompany transfers of stock in 1998 and 1999. Based upon statutory guidelines, Tyco International estimates the proposed penalties could range between $30 million and $50 million. The penalty is asserted against a prior subsidiary of Tyco International that was distributed to us in connection with the separation. Any penalty ultimately imposed upon our subsidiary would be subject to sharing with Tyco International and Covidien under the Tax Sharing Agreement. It is our understanding that Tyco International continues to make progress towards resolving a substantial number of proposed tax adjustments for the years 1997 through 2000; however, several significant matters remain in dispute. The remaining issues in dispute involve the tax treatment of certain intercompany debt transactions. Tyco International has indicated that it is unlikely to achieve the resolution of these contested adjustments through the IRS appeals process, and therefore may be required to litigate the disputed issues. In the first nine months of fiscal 2012, we made payments of $70 million for tax deficiencies related to undisputed tax adjustments for the years 1997 through 2000. Concurrent with remitting these payments, we were reimbursed $44 million from Tyco International and Covidien pursuant to their indemnifications for pre-separation tax matters. For those issues not in dispute, we expect the IRS to complete its examination for the years 1997 through 2000 and issue special agreement Forms 870-AD by early fiscal 2013. Over the next twelve months, we expect to pay approximately $26 million, inclusive of related indemnification payments, in connection with these pre-separation tax matters.
Legal Matters
In the ordinary course of business, we are subject to various legal proceedings and claims, including patent infringement claims, product liability matters, employment disputes, disputes on agreements, other commercial disputes, environmental matters, antitrust claims, and tax matters, including non-income tax matters such as value added tax, sales and use tax, real estate tax, and
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transfer tax. Management believes that these legal proceedings and claims likely will be resolved over an extended period of time. Although it is not feasible to predict the outcome of these proceedings, based upon our experience, current information, and applicable law, we do not expect that the outcome of these proceedings, either individually or in the aggregate, will have a material effect on our results of operations, financial position, or cash flows. See Note 11 to the Condensed Consolidated Financial Statements for additional information regarding legal proceedings.
At June 29, 2012, we had a contingent purchase price commitment of $80 million related to our fiscal 2001 acquisition of Com-Net. This represents the maximum amount payable to the former shareholders of Com-Net only after the construction and installation of a communications system for the State of Florida was completed and approved by the State of Florida in accordance with guidelines set forth in the contract. Under the terms of the purchase and sale agreement, we do not believe we have any obligation to the sellers. However, the sellers have contested our position and initiated a lawsuit in June 2006 in the Court of Common Pleas in Allegheny County, Pennsylvania, which is in the discovery phase. A liability for this contingency has not been recorded on the Condensed Consolidated Financial Statements as we do not believe that any payment is probable or reasonably estimable at this time.
Off-Balance Sheet Arrangements
Certain of our segments have guaranteed the performance of third parties and provided financial guarantees for uncompleted work and financial commitments. The terms of these guarantees vary with end dates ranging from fiscal 2012 through the completion of such transactions. The guarantees would be triggered in the event of nonperformance, and the potential exposure for nonperformance under the guarantees would not have a material effect on our results of operations, financial position, or cash flows.
We have recorded liabilities for known indemnifications included as part of environmental liabilities. See Note 11 to the Condensed Consolidated Financial Statements for a discussion of these liabilities.
Pursuant to the Separation and Distribution Agreement and Tax Sharing Agreement, upon separation, we entered into certain guarantee commitments and indemnifications with Tyco International and Covidien. Under these agreements, principally the Tax Sharing Agreement, we, Tyco International, and Covidien share 31%, 27%, and 42%, respectively, of certain contingent liabilities relating to unresolved pre-separation tax matters of Tyco International. The effect of the Tax Sharing Agreement is to indemnify us for 69% of certain liabilities settled in cash by us with respect to unresolved pre-separation tax matters. Pursuant to that indemnification, we have made similar indemnifications to Tyco International and Covidien with respect to 31% of certain liabilities settled in cash by the companies relating to unresolved pre-separation tax matters. If any of the companies
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responsible for all or a portion of such liabilities were to default in its payment of costs or expenses related to any such liability, we would be responsible for a portion of the defaulting party or parties' obligation. These arrangements have been valued upon our separation from Tyco International in accordance with Accounting Standards Codification ("ASC") 460, Guarantees, and, accordingly, liabilities amounting to $239 million were recorded on the Condensed Consolidated Balance Sheet at June 29, 2012. See Notes 10 and 11 to the Condensed Consolidated Financial Statements for additional information.
Critical Accounting Policies and Estimates
The preparation of the Condensed Consolidated Financial Statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities, and the reported amounts of revenue and expenses.
Our accounting policies for revenue recognition, goodwill and other intangible assets, income taxes, pension and postretirement benefits, share-based compensation, and acquisitions are based on, among other things, judgments and assumptions made by management. During the nine months ended June 29, 2012, there were no significant changes to these policies or to the underlying accounting assumptions and estimates used in these policies from those disclosed in the Consolidated Financial Statements and accompanying notes contained in our Annual Report on Form 10-K for the fiscal year ended September 30, 2011.
Accounting Pronouncements
In December 2011 and June 2011, the Financial Accounting Standards Board ("FASB") issued updates to guidance in ASC 220, Comprehensive Income, that change the presentation and disclosure requirements of comprehensive income in interim and annual financial statements. These updates to ASC 220 are effective for us in the first quarter of fiscal 2013; however, we expect to early adopt these standards during the fourth quarter of fiscal 2012. Adoption is not expected to have a material impact on our Condensed Consolidated Financial Statements.
Non-GAAP Financial Measures
Organic Net Sales Growth
Organic net sales growth is a non-GAAP financial measure. The difference between reported net sales growth (the most comparable GAAP measure) and organic net sales growth (the non-GAAP measure) consists of the impact from foreign currency exchange rates, acquisitions, divestitures, and an additional week in the fourth quarter of the fiscal year for fiscal years which are 53 weeks in length. Organic net sales growth is a useful measure of the underlying results and trends in our business. It excludes items that are not completely under management's control, such as the impact of changes in foreign currency exchange rates, and items that do not reflect the underlying growth of the company, such as acquisition and divestiture activity and the impact of an additional week in the fourth quarter of the fiscal year for fiscal years which are 53 weeks in length.
We believe organic net sales growth provides useful information to investors because it reflects the underlying growth from the ongoing activities of our business. Furthermore, it provides investors with a view of our operations from management's perspective. We use organic net sales growth to monitor and evaluate performance, as it is an important measure of the underlying results of our operations. Management uses organic net sales growth together with GAAP measures such as net sales growth and operating income in its decision making processes related to the operations of our reporting segments
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and our overall company. We believe that investors benefit from having access to the same financial measures that management uses in evaluating operations. The discussion and analysis of organic net sales growth in Results of Operations above utilizes organic net sales growth as management does internally. Because organic net sales growth calculations may vary among other companies, organic net sales growth amounts presented above may not be comparable with similarly titled measures of other companies. Organic net sales growth is a non-GAAP financial measure that is not meant to be considered in isolation or as a substitute for GAAP measures. The primary limitation of this measure is that it excludes items that have an impact on our net sales. This limitation is best addressed by evaluating organic net sales growth in combination with our GAAP net sales. The tables presented in Results of Operations above provide reconciliations of organic net sales growth to net sales growth calculated under GAAP.
Free Cash Flow
Free cash flow is a non-GAAP financial measure. The difference between net cash provided by continuing operating activities (the most comparable GAAP measure) and free cash flow (the non-GAAP measure) consists mainly of significant cash outflows and inflows that we believe are useful to identify. Free cash flow is a useful measure of our performance and ability to generate cash. It also is a significant component in our incentive compensation plans. We believe free cash flow provides useful information to investors as it provides insight into the primary cash flow metric used by management to monitor and evaluate cash flows generated from our operations.
Free cash flow excludes net capital expenditures, voluntary pension contributions, and the cash impact of special items. Net capital expenditures are subtracted because they represent long-term commitments. Voluntary pension contributions are subtracted from the GAAP measure because this activity is driven by economic financing decisions rather than operating activity. Certain special items, including net payments related to pre-separation tax matters, are also considered by management in evaluating free cash flow. We believe investors should also consider these items in evaluating our free cash flow.
Free cash flow as presented herein may not be comparable to similarly-titled measures reported by other companies. The primary limitation of this measure is that it excludes items that have an impact on our GAAP cash flow. Also, it subtracts certain cash items that are ultimately within management's and the board of directors' discretion to direct and may imply that there is less or more cash available for our programs than the most comparable GAAP measure indicates. This limitation is best addressed by using free cash flow in combination with the GAAP cash flow results. It should not be inferred that the entire free cash flow amount is available for future discretionary expenditures, as our definition of free cash flow does not consider certain non-discretionary expenditures, such as debt payments. In addition, we may have other discretionary expenditures, such as discretionary dividends, share repurchases, and business acquisitions, that are not considered in the calculation of free cash flow.
The tables presented in Liquidity and Capital Resources above provide reconciliations of free cash flow to cash flows from continuing operating activities calculated under GAAP.
Forward-Looking Information
Certain statements in this quarterly report on Form 10-Q are "forward-looking statements" within the meaning of the U.S. Private Securities Litigation Reform Act of 1995. These statements are based on our management's beliefs and assumptions and on information currently available to our management. Forward-looking statements include, among others, the information concerning our possible or assumed future results of operations, business strategies, financing plans, competitive position, potential growth opportunities, potential operating performance improvements, acquisitions, the effects of competition, and the effects of future legislation or regulations. Forward-looking
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statements include all statements that are not historical facts and can be identified by the use of forward-looking terminology such as the words "believe," "expect," "plan," "intend," "anticipate," "estimate," "predict," "potential," "continue," "may," "should," or the negative of these terms or similar expressions.
Forward-looking statements involve risks, uncertainties, and assumptions. Actual results may differ materially from those expressed in these forward-looking statements. You should not put undue reliance on any forward-looking statements. We do not have any intention or obligation to update forward-looking statements after we file this report except as required by law.
The following and other risks, which are described in greater detail in "Part I. Item 1A. Risk Factors" in our Annual Report on Form 10-K for the fiscal year ended September 30, 2011 and in "Part II. Item 1A. Risk Factors" in our Quarterly Report on Form 10-Q for the quarterly period ended December 30, 2011, could also cause our results to differ materially from those expressed in forward-looking statements:
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There may be other risks and uncertainties that we are unable to predict at this time or that we currently do not expect to have a material adverse effect on our business.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
There have been no significant changes in our exposures to market risk during the first nine months of fiscal 2012. For further discussion of our exposures to market risk, refer to "Part II. Item 7A. Quantitative and Qualitative Disclosures About Market Risk" in our Annual Report on Form 10-K for the fiscal year ended September 30, 2011.
ITEM 4. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
Our management, with the participation of our chief executive officer and chief financial officer, evaluated the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended (the "Exchange Act")), as of June 29, 2012. Based on that evaluation, our chief executive officer and chief financial officer concluded that our disclosure controls and procedures were effective as of June 29, 2012.
Changes in Internal Control Over Financial Reporting
During the quarter ended June 29, 2012, there were no changes in our internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Deutsch Acquisition
We acquired Deutsch on April 3, 2012. For additional information regarding the acquisition, refer to Note 4 to the Condensed Consolidated Financial Statements and "Part I. Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations—Acquisition" included in this Quarterly Report.
We will exclude the Deutsch operations from the scope of our annual assessment of the effectiveness of internal control over financial reporting for the year ending September 28, 2012 in accordance with SEC guidance regarding the reporting of internal control over financial reporting in connection with a recent acquisition. Such guidance permits management to omit an assessment of an acquired business' internal control over financial reporting from management's assessment of internal control over financial reporting for a period not to exceed one year. We are in the process of integrating the Deutsch operations within our internal control structure and expect that this effort will be completed in fiscal 2013.
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PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
There have been no material developments in our legal proceedings since we filed our Quarterly Report on Form 10-Q for the quarterly period ended March 30, 2012. For a description of our previously reported legal proceedings, refer to "Part I. Item 3. Legal Proceedings" in our Annual Report on Form 10-K for the fiscal year ended September 30, 2011 and "Part II. Item 1. Legal Proceedings" in our Quarterly Report on Form 10-Q for the quarterly period ended December 30, 2011.
ITEM 1A. RISK FACTORS
There have been no material changes in our risk factors from those disclosed in "Part I. Item 1A. Risk Factors" in our Annual Report on Form 10-K for the fiscal year ended September 30, 2011, other than as set forth in "Part II. Item 1A. Risk Factors" in our Quarterly Report on Form 10-Q for the quarterly period ended December 30, 2011. The risk factors disclosed in our Annual Report on Form 10-K and subsequent Quarterly Report on Form 10-Q, in addition to other information set forth in this report, could materially affect our business operations, financial condition, or liquidity. Additional risks and uncertainties not currently known to us or that we currently believe are immaterial also may impair our business operations, financial condition, and liquidity.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
Recent Sales of Unregistered Securities
None.
Issuer Purchases of Equity Securities
The following table presents information about our purchases of our common shares during the quarter ended June 29, 2012:
March 31 - April 27, 2012
April 28 - June 1, 2012
June 2 - June 29, 2012
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
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ITEM 4. MINE SAFETY DISCLOSURES
Not applicable.
ITEM 5. OTHER INFORMATION
ITEM 6. EXHIBITS
Neither TE Connectivity Ltd. nor any of its consolidated subsidiaries has outstanding any instrument with respect to its long-term debt, other than those filed as an exhibit to TE Connectivity Ltd.'s Annual Report on Form 10-K for the fiscal year ended September 30, 2011, Quarterly Report on Form 10-Q for the quarterly period ended December 30, 2011, or Quarterly Report on Form 10-Q for the quarterly period ended March 30, 2012, under which the total amount of securities authorized exceeds 10% of the total assets of TE Connectivity Ltd. and its subsidiaries on a consolidated basis. TE Connectivity Ltd. hereby agrees to furnish to the U.S. Securities and Exchange Commission, upon request, a copy of each instrument that defines the rights of holders of such long-term debt that is not filed or incorporated by reference as an exhibit to our annual and quarterly reports.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Date: July 26, 2012
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